Canadian Tax Journal, Vol. 56, No. 4, 2008

canadian tax journal / revue fiscale canadienne (2008) vol. 56, n o 4, 1038 - 57
Current Tax Reading
Co-Editors: Tim Edgar, Jinyan Li, Alan Macnaughton, and
Amin Mawani*
United States, Joint Committee on Taxation, A Reconsideration of Tax Expenditure
Analysis (Washington, DC: Joint Committee on Taxation, May 2008) (available
on the Web at http://www.house.gov/jct/x-37-08.pdf ), 84 pages
Since the tax expenditure concept was popularized over 40 years ago by Stanley
Surrey, it has been contentious. The concept is deceptively simple. Governments
can choose to deliver the equivalent of direct spending programs through the tax
system by permitting the reduction of tax liability through deductions, credits, or
beneficial timing rules. Proponents have argued that tax expenditure analysis helps
to clarify the amount of government spending while providing an analytical tool to
assess the desirability of particular tax rules. Critics have emphasized the problematic nature of a perceived need to identify a normal or benchmark tax base as a
premise for the characterization of deviations as equivalent to spending programs.
They argue that disagreement over an appropriate benchmark severely undermines
the usefulness of the tax expenditure concept.
This study is the first in a proposed series intended to reinvigorate tax expenditure analysis as an element of the budgetary and tax policy-making process in the
United States.1 The staff of the Joint Committee on Taxation ( jct) have always been
intimately involved in the production of tax expenditure accounts, which the Congressional Budget Office (cbo) and the Treasury department have been required by
law since 1974 to publish annually. The cbo has relied especially on the expertise
of the jct staff in revenue analysis, which has been necessary both in characterizing
particular provisions as the equivalent of spending programs and in determining the
associated cost. In an attempt to avoid the characterization problems of the past,
* Tim Edgar is of the Faculty of Law, University of Western Ontario, London, and a senior
research fellow, Taxation Law and Policy Research Institute, Monash University, Melbourne.
Jinyan Li is of Osgoode Hall Law School, York University. Alan Macnaughton is the holder of
the KPMG professorship in accounting at the University of Waterloo. Amin Mawani is of the
Schulich School of Business, York University. The initials below each review identify the
author of the review; the two co-editors with the initials A.M. are distinguished by including
the first name.
1 See also J. Clifton Fleming Jr. and Robert J. Peroni, “Reinvigorating Tax Expenditure Analysis
and Its International Dimension” (2008) vol. 27 no. 3 Virginia Tax Review 437-562, reviewed in
this feature (2008) vol. 56, no. 3 Canadian Tax Journal 790-802 at 796.
1038 current tax reading n 1039
the study introduces “a new paradigm for classifying tax provisions as tax expenditures.”2 It proposes that tax provisions be characterized as tax expenditures if they
can be considered either (1) “deliberately inconsistent with an identifiable general
rule of the present tax law”3 (referred to as “tax subsidies”); or (2) a structural element of the Internal Revenue Code4 that “materially affect[s] economic decisions in
a manner that imposes substantial efficiency costs”5 (referred to as “tax-induced
structural distortions”). By using the existing provisions of us income tax law as the
reference point, the new paradigm attempts to avoid the contentiousness that surrounds the articulation of a normal tax. After reviewing the historical development
of tax expenditure analysis in the United States, as well as the standard critiques, the
study elaborates the proposed taxonomy in some detail, including a discussion of
three subcategories of tax subsidies: (1) tax transfers, (2) social spending, and (3) business synthetic spending. The penultimate part of the study discusses an “economic
evaluation” of tax expenditures, using the refundable earned income credit, individual retirement accounts, and the research and experimental development credit as
illustrative examples. The final part reviews recent methodology used to estimate
the cost of tax expenditures and describes a proposed new methodology.
The study emphasizes the use of the tax expenditure concept as an analytical
tool. Indeed, the proposed approach to characterization is intended to allow tax
expenditure analysis to serve “as an effective and neutral analytical tool for policymakers in their consideration of individual tax proposals or larger tax reforms.”6 This
emphasis is much different from that in other countries, including Canada, where
the tax expenditure concept appears to be used primarily as a budgetary accounting
tool. The study downplays this role, perhaps because of the apparent failure of the
tax expenditure account to control us federal government spending. In this respect,
the study notes that the first description of tax expenditures in 1972 consisted of 60
items. Thirty-five years later, the description had expanded to 170 items using the
same characterization approach.7 Yet the tax expenditure concept may well have its
singularly independent policy significance in performing a budgetary accounting
function. Characterization problems are much less problematic when the concept is
limited to this role; in particular, considerations of government accountability seem
to suggest an inclusive approach to characterization. In short, such considerations
support the inclusion of tax provisions as tax expenditures whenever they can conceivably be considered the equivalent of direct spending programs, recognizing of
course the unique problems of revenue estimation. The emphasis on a budgetary
2 At 1.
3 At 9.
4 Internal Revenue Code of 1986, as amended (hereinafter referred to as “the Code”).
5 At 10.
6 At 1.
7 At 4.
1040 n canadian tax journal / revue fiscale canadienne
(2008) vol. 56, n o 4
accounting function may be responsible, at least in part, for the much less contentious status of the tax expenditure account in other countries.
Even the relatively brief discussion in the study leaves one wondering whether
the suggested characterization approach really does much to advance the whole tax
expenditure enterprise as a tax policy-making tool. Because the suggested categories
are in no way self-executing, it is not obvious that the frame of reference suggested in
the study solves what is probably an insoluble problem. For example, the study cites
tax relief for charitable donations as a supposedly clear example of a tax provision in
its tax subsidy category. It is not obvious, however, that tax relief for charitable donations, in the form of either a tax credit or an income deduction, can be considered
deliberately inconsistent with an identifiable general rule of the present tax law.
Similar characterization questions arise with the two examples of tax-induced structural distortions cited in the study: the deferral of foreign-source income earned
through a non-resident corporation and the different treatment of corporate interest
expense and dividends. Perhaps most importantly, it is not clear that characterization of a tax provision as a tax expenditure provides anything unique for analytical
purposes. Adopting a stance of tax policy agnosticism on the characterization issue,
policy makers can defensibly posit any set of rule choices, with the possibilities assessed
on the basis of their efficiency and distributional effects as well as their administrative
and compliance costs. Labelling a particular rule a tax expenditure does absolutely
nothing to advance this necessary policy analysis of the consequential attributes of
possible rule choices. At best, the tax expenditure process becomes the occasion for
engaging in the necessary policy analysis. But that is a matter of convenience only,
not a matter of necessity.
The next two instalments in the proposed series will apparently continue the
focus on the tax expenditure concept as an analytical tool in the policy-making process. One instalment will consist of a list of tax expenditures characterized as tax
subsidies, along with a discussion of the reasons for classification in one of the suggested subcategories. The other instalment will list tax provisions considered to be
tax-induced structural distortions. It will also identify inefficiencies attributable to
the identified distortions, and will tentatively describe some possible solutions.
T.E.
Mark P. Gergen, “How Corporate Integration Could Kill the Market for
Corporate Tax Shelters” (2008) vol. 61, no. 2 Tax Law Review 145-67
The author argues that the literature on corporate income tax integration in the
United States has overlooked the effect that integration proposals could have on
the market for corporate tax shelters. His fundamental proposition is that taxing
corporate income at shareholder tax rates creates a conflict among shareholders
subject to different tax rates or with different investment time horizons. The conflict
arises because of the different valuations shareholders place on the benefit of tax
shielding provided by corporate tax-shelter transactions, and the conflict could potentially kill the market for such transactions. As Gergen observes, either a conduit
current tax reading n 1041
integration model or a shareholder imputation-credit model, with fully refundable
credits, could realize the necessary condition of taxing corporate income at shareholder tax rates. Although a dividend-exclusion model would also create a divergence
in payoffs from shielding, tax-exempt shareholders and taxable shareholders with
relatively long investment time horizons would have similar payoffs. This particular
integration model would be less likely, therefore, to deter shielding.
Gergen recognizes, and discusses briefly, the practice of dividend streaming as a
means to avoid conflict by segmenting shareholders and delivering the benefit of
shielding to those shareholders who value it most. In fact, dividend streaming has
been a significant problem for countries with dividend imputation systems, and it
has necessitated specific anti-avoidance legislation. Gergen also recognizes that there
are other important variables that would affect the impact of corporate integration
on tax shielding, including the shape of the cost curve for shielding transactions, the
inclination of firms to use tax shields, and the demand by taxable investors for shares
held outside tax-deferred accounts. Empirical researchers might attempt to test his
model with a comparison of corporate shielding behaviour in imputation and nonimputation countries. An important additional independent variable for such a study
would be the possible different degrees of effectiveness of anti-avoidance doctrines
and/or general anti-avoidance rules, as well as specific anti-streaming rules, in deterring tax-shielding transactions.
T.E.
Arthur J. Cockfield, Finding Silver Linings in the Storm: An Evaluation of
Recent Canada-US Crossborder Tax Developments, C.D. Howe Institute
Commentary no. 272 (Toronto: C.D. Howe Institute, 2008) (available
on the Web at http://www.cdhowe.org), 23 pages
This commentary consists of three parts. The first part reviews recent changes to
the Canada-us treaty8 that reduce barriers to cross-border investment. The changes
include the elimination of interest withholding tax, the extension of treaty benefits
to us limited liability corporations, and the provision of binding arbitration. The
second part considers Canada’s continuing effort to engage in tax competition
through reductions of the corporate income tax rate while at the same time attempting
to eliminate the tax benefit associated with the availability of an unrestricted interest
expense deduction in the context of outbound direct investment. The third part
suggests some further initiatives that would reduce tax barriers to Canada-us crossborder investment. Perhaps most importantly, Cockfield argues that the Department
of Finance should consider eliminating dividend withholding tax on parent-subsidiary
dividends, despite the substantial revenue cost of doing so. He also suggests the
8 The Convention Between Canada and the United States of America with Respect to Taxes on
Income and on Capital, signed at Washington, DC on September 26, 1980, as amended by the
protocols signed on June 14, 1983, March 28, 1984, March 17, 1995, and July 29, 1997.
1042 n canadian tax journal / revue fiscale canadienne
(2008) vol. 56, n o 4
provision of cross-border corporate loss relief, recognizing, however, that Canada
must first enact some form of relief in a domestic context. His other suggestion of
a broader availability of rollover relief for cross-border mergers and acquisitions is
probably more feasible, at least in the short term.
T.E.
Thomas Rixen, “A Politico-Economic Perspective on International Double
Taxation Avoidance” (2008) vol. 49, no. 7 Tax Notes International 599-617
Eduardo Baistrocchi, “The Use and Interpretation of Tax Treaties in
the Emerging World: Theory and Implications” [2008] no. 4 British
Tax Review 352-91
(2008) vol. 14, no. 2 New Zealand Journal of Taxation Law and Policy 115-291
The subject of tax treaties has always occupied a significant corner of the international tax literature. Much of that literature is descriptive, with a focus on technical
interpretive issues arising in the context of treaties between developed countries.
However, the role of bilateral tax treaties in distributing revenue between developed
and developing countries appears to be gaining some ground as a fashionable topic
in academic circles. There is some substance to this fashion in the sense that it is
driven in no small part by the increasing economic importance of the developing
world. The burgeoning literature on tax treaties between developed and developing
countries is refreshingly interesting primarily for its attempt to frame the subject by
using theoretical insights from political theory and theories of distributive justice.
Rixen’s article is based on a chapter in his book on the political economy of the
international tax system.9 It is an especially good example of an attempt to approach
the subject of tax treaties from the fresh perspective of a political economist. Rixen
uses regression analysis to show that the terms of bilateral tax treaties vary systematically with the relative investment flows of the treaty partners. He interprets this
result as evidence that bilateral agreements can best accommodate the concern of
treaty partners about the distribution of tax revenues and other benefits associated
with the tax base. More broadly, he frames the international tax system, implemented
through bilateral treaties, as a coordination game with a distributive conflict that is
the outcome of either symmetrical or asymmetrical investment flows between treaty
partners. He argues, however, that the oecd model treaty10 performs the important
function of providing a focal point for bilateral bargains. Moreover, because the
strategic structure of the international tax system is a coordination game, the relevant
9 Thomas Rixen, The Political Economy of International Tax Governance (Basingstoke, UK: Palgrave
Macmillan, 2008).
10 Organisation for Economic Co-operation and Development, Model Tax Convention on Income
and on Capital: Condensed Version (Paris: OECD) (looseleaf ).
current tax reading n 1043
institutions do not have to have an enforcement power, which explains the prevalence of the mutual agreement procedure.
Baistrocchi’s article considers two aspects of what he refers to as “the asymmetric
tax treaty network.” He coins this term to refer to treaties between developed and
developing countries; the asymmetry is the imbalance of capital flows between the
treaty partners. The first aspect is the fundamental question why a developing country would ever enter into a tax treaty based on the oecd model with a developed
country, since the oecd model clearly ignores many important interests of the
partner who is a net capital importer. The second aspect is the structure of incentives that the courts of developing countries face when interpreting a tax treaty with
a developed country in the context of foreign direct investment. Baistrocchi argues
that the same strategic interaction explains both: (1) the reason that developing countries enter into tax treaties based on the oecd model with developed countries, and
(2) the pattern of development of the treaty network as interpreted by domestic
courts. More particularly, he suggests that competition among developing countries
for foreign direct investment leads them to enter into tax treaties with developed
countries, and that the oecd model is used because of its associated network features.
That is, the oecd model provides the basis for a network market of international
tax systems that has certain positive externalities, including minimization of communication and enforcement costs and reputational advantages over rivals that do
not belong to the network. These same interactions are suggested as explanations
for a tendency of domestic courts to interpret tax treaties in favour of taxpayers.
Baistrocchi uses a decision of the Indian Supreme Court11 as a case study of his theory
of tax treaty interpretation. More systematic empirical testing of his theory is an
obvious direction for further research.
This issue of the New Zealand Journal of Taxation Law and Policy consists of five
articles on various aspects of New Zealand’s tax treaty policy. In general, the articles
are more descriptive than theoretical in their approaches. Nonetheless, because
New Zealand is a small open economy that is a net capital importer, its extensive
treaty experience should be particularly instructive for developing countries. The
first article in the issue12 provides an overview of the development of New Zealand’s
tax treaty policy and practice, with a particular focus on deviations from the oecd
model in an effort to extend source taxation. The second article13 considers New
Zealand’s approach to the alienation of property (oecd model, article 13). The
third article14 reviews the possible impact of the oecd’s proposed approach to the
11 Union of India v. Azadi Bachao Andolan (2003), 56 SC ITR 563.
12 Graham Hunt, “New Zealand’s Evolving Approach to Tax Treaties,” 131-67.
13 John Marney, “Alienation of Property Articles in New Zealand’s Double Tax Agreements,”
170-96.
14 Andrea Black, “The ‘Authorised’ OECD Approach to the Attribution of Profits to Permanent
Establishments: Implications for New Zealand and Other Source Countries,” 197-230.
1044 n canadian tax journal / revue fiscale canadienne
(2008) vol. 56, n o 4
determination of branch profits (oecd model, article 7).15 The fourth article16
focuses on New Zealand’s somewhat unusual approach to the provision of dividend
imputation credits to non-resident shareholders. The fifth article17 considers the
relationship between controlled foreign corporation rules and tax treaties.
T.E.
John Avery Jones, Peter Harris, and David Oliver, eds., Comparative
Perspectives on Revenue Law: Essays in Honour of John Tiley
(Cambridge: Cambridge University Press, 2008), 327 pages
This volume of essays commemorates the recent retirement of John Tiley, a longserving tax academic in the Faculty of Law at Cambridge University. Many of the
essays are written on subjects that Tiley has addressed in his own considerable body
of work. For example, five of the essays deal with the subject of tax avoidance. In
this respect, Canadian readers may be familiar with Tiley’s paper published in the
report of proceedings of the Canadian Tax Foundation’s 1988 annual conference.18
The paper has been cited judicially on numerous occasions for its discussion of the
extended meaning of “a series of transactions” in subsection 248(10) of the Income
Tax Act.19 Some of the other essays also reflect Tiley’s keen interest in tax history.
The essay titles and the contributors, who are all well-known colleagues in various
capacities from several countries, are as follows:
Brian Arnold, “A Comparison of Statutory General Anti-Avoidance Rules
and Judicial General Anti-Avoidance Doctrines as a Means of Controlling
Tax Avoidance: Which Is Better? (What Would John Tiley Think?)”;
n Malcolm Gammie, “The Judicial Approach to Avoidance: Some Reflections
on bmbf and spi ”;
n Martin McMahon, “Comparing the Application of Judicial Interpretative
Doctrines to Revenue Statutes on Opposite Sides of the Pond”;
n Wolfgang Schön, “Abuse of Rights and European Tax Law”;
n Erik M. Jensen, “The us Legislative and Regulatory Approach to Tax
Avoidance”;
n
15 Organisation for Economic Co-operation and Development, Discussion Draft on the Attribution of
Profits to Permanent Establishments (PEs) (Paris: OECD, 2004), part I (General Considerations).
16 Carolyn Palmer, “The International Tax Consequences of New Zealand’s Imputation System:
Past, Present and Future,” 231-61.
17 James M. Halse, “The Conflict Between CFC Legislation and Double Tax Treaties: A New
Zealand Perspective,” 262-91.
18 John Tiley, “Series of Transactions,” in Report of Proceedings of the Fortieth Tax Conference, 1988
Conference Report (Toronto: Canadian Tax Foundation, 1989), 8:1-22.
19 RSC 1985, c. 1 (5th Supp.), as amended (herein referred to as “the Act”).
current tax reading n 1045
Graham Virgo, “The Law of Taxation and Unjust Enrichment”;
Richard Vann, “The History of Royalties in Tax Treaties 1921-61: Why?”;
n Martin Daunton, “Land Taxation, Economy and Society in Britain and Its
Colonies”;
n John Avery Jones, “Meade and Inheritance Tax”;
n Philip Baker, “Taxation, Human Rights and the Family”; and
n David Oliver and Peter Harris, “Family Connections and the Corporate
Entity: Income Splitting Through the Family Company.”
n
n
The volume also includes two forewords that reflect on Tiley’s contributions as a
teacher and a scholar. A thoughtful epilogue considers his role in helping to establish tax law as a mainstream academic subject at uk universities.
T.E.
Ari J. Brandes, “A Better Way To Understand Credit Default Swaps”
(2008) vol. 120, no. 3 Tax Notes 235-51
Because of their role in the great credit crisis of 2007-2008, credit default swaps
(cdss) have been discussed widely in the popular press but have not yet received
much attention in the tax literature.20 This article, written by a student at Georgetown University Law Center, is a welcome addition to the literature. It provides a
comprehensive technical account and analysis of the us income tax treatment of
cdss. It also offers some interesting observations on normative considerations relevant to the treatment of these important derivative financial instruments. Brandes
characterizes the cds as one particular type of derivative instrument, which he labels
an “annuity-paid deep out-of-the money derivative contract,” or apdo. An apdo is
characterized by asymmetric cash flows, with one counterparty agreeing to make a
single payment on the occurrence of an event out of the control of the parties in return
for the other counterparty agreeing to pay an “annuity-like stream of payments.”
T.E.
Mark Pizzacalla, “Global SME Tax Policy Conundrum”
(2008) vol. 23, no. 1 Australian Tax Forum 49-88
The author reviews the income tax treatment of small and medium-sized enterprises
(smes) in Australia and draws comparisons with the treatment of smes in the United
Kingdom and the United States. His conclusions are depressingly familiar. He
characterizes the Australian treatment as ad hoc and politically driven. The losers
are not only Australian taxpayers generally; in many instances, poorly targeted tax
20 A notable exception is New York State Bar Association, Tax Section, “Notice 2004-53
(Credit Default Swaps),” Report no. 1095, September 9, 2005 (available on the Web at
http://www.nysba.org).
1046 n canadian tax journal / revue fiscale canadienne
(2008) vol. 56, n o 4
concessions have had adverse effects for Australian smes themselves. A table at the
end of the article summarizes sme outcomes under major Australian tax reforms
from 1975 to 2007.
T.E.
Anthony C. Infanti, “Deconstructing the Duty to the Tax System:
Unfettering Zealous Advocacy on Behalf of Lesbian and Gay
Taxpayers” (2008) vol. 61, no. 2 The Tax Lawyer 407-44
The conventional position is that a tax lawyer’s principal professional responsibility
is the advancement of his or her client’s interests. This paramount duty to the client
is tempered somewhat by a duty to ensure the proper functioning of the tax system.
What the author refers to as the lawyer’s “unbridled loyalty” to the client could
otherwise permit the strategic, and potentially abusive, use of certain advantages
that taxpayers already have over tax administrators. Infanti argues, however, that
this “heteronormative” view of the necessary balance between a tax lawyer’s duty to
the client and his or her duty to the tax system does not hold when it comes to advocacy on behalf of gay and lesbian clients, who suffer systemic discrimination under
tax laws. In contrast with advocacy on behalf of heterosexual taxpayers, where the
duty to the client and the duty to the tax system are in a constant state of tension,
the tax lawyer’s duty of zealous advocacy on behalf of the lesbian or gay client is
largely in harmony with his or her duty to the tax system.
T.E.
Michael J. Graetz, “A Multilateral Solution for the Income
Tax Treatment of Interest Expenses” (2008) vol. 62, no. 11
Bulletin for International Taxation 486-93
Harry Grubert, “Debt and the Profitability of Foreign-Controlled Domestic
Corporations in the United States,” OTA Technical Working Paper no. 1
(Washington, DC: Office of Tax Analysis, July 2008), 31 pages
The deductibility of interest expense in the context of both outbound and inbound
direct investment is an increasingly prominent tax-policy issue. In an apparent response to recent European Court of Justice case law,21 Denmark, Germany, and Italy
have enacted comprehensive restrictions based on specified interest coverage ratios
characteristic of earnings-stripping legislation. Australia and New Zealand have
enacted similarly comprehensive thin capitalization legislation limiting the deduction of interest expense on arm’s-length and related-party debt in the context of
outbound and inbound direct investment. After the false start of the March 2007
21 The dismantling of thin capitalization regimes in EU countries began with the decision in
Lankhorst-Hohorst GmbH v. Finanzamt Steinfurt, case C-324/00, [2002] ECR I-11779
(characterizing the former German legislation as violating the right to freedom of establishment).
current tax reading n 1047
budget proposal to restrict the deduction of interest expense that can be traced to
the earning of exempt surplus of a foreign affiliate, the Department of Finance recently introduced section 18.2 of the Act, which imposes a more narrowly focused
non-deductibility rule for interest expense that can be linked to certain tax-effective
outbound structures. Completing this policy agenda is one of the more important
areas of concern singled out by the Advisory Panel on Canada’s System of International Taxation—the adequacy of deductibility restrictions imposed by the existing
thin capitalization rules in subsections 18(4) to (6) of the Act in the context of inbound direct investment.22
Graetz argues that the policy case for interest deductibility restrictions has been
incorrectly framed as discrete inquiries in the context of either outbound or inbound
direct investment. But rather than the comprehensive approaches of Australia,
Denmark, Germany, Italy, and New Zealand, which impose symmetrical restrictions
in respect of both outbound and inbound direct investment, he prefers a proportionate allocation of interest expense among countries based on asset value. He rejects
the kind of modified asset or revenue-based apportionment characteristic of the
legislation in these countries on the apparent basis that they unnecessarily sacrifice
revenue for perceived increases in national welfare attributable to additional investment. The tradeoff between revenue maintenance and welfare gains is realized in a
blunt sense by the provision, under these legislative regimes, of a safe harbour
amount of permissible interest expense. The safe harbour effectively softens the
strict application of either asset-based or revenue-based apportionment of interest
expense. Graetz sounds the call, instead, for the implementation of an unmodified
asset-based allocation. To ensure the single deduction of interest expense in a single
country, this kind of allocation would ideally be adopted on a multilateral basis, with
the necessary project spearheaded by the oecd.
Grubert provides an empirical analysis, using 2004 tax return data, of the debt
levels and associated profitability of foreign-controlled domestic corporations
(fcdcs) in the United States. Much of the analysis was previously incorporated, in a
less technical manner, in a recent report of the us Treasury department to Congress
on the earnings-stripping rule in Code section 163( j).23 Grubert makes three principal points in his empirical study. First, domestically controlled corporations (dccs)
in the manufacturing and non-financial sectors have higher levels of profitability
than fcdcs, but the difference disappears when dividends, interest, and royalties are
subtracted from net income, since dccs receive much greater amounts of such income from their subsidiaries operating abroad. Second, compared with dccs,
fcdcs in the non-financial sector do not on average pay a larger portion of their cash
flows in interest expense. Moreover, fcdcs are less likely to have levels of interest
22 Advisory Panel on Canada’s System of International Taxation, Enhancing Canada’s International
Tax Advantage (Ottawa: Department of Finance, 2008), 29-32.
23 United States, Department of the Treasury, Report to the Congress on Earnings Stripping, Transfer
Pricing and U.S. Income Tax Treaties (Washington, DC: Department of the Treasury, 2007), 7-31.
1048 n canadian tax journal / revue fiscale canadienne
(2008) vol. 56, n o 4
expense in excess of 50 percent of ebitda (earnings before interest, taxes, and depreciation allowance), which is the interest-coverage ratio specified in Code section
163( j). Third, as compared with dccs, fcdcs in the finance sector (that is, commercial banks, securities dealers, and investment banks) pay on average a larger
portion of their cash flows in interest expense, and they are more likely to have
higher levels of debt. In the insurance and real estate sectors, however, fcdcs exhibit a wider range of profitability and debt levels than their dcc counterparts.
T.E.
United States, Government Accountability Office, U.S. Multinational
Corporations: Effective Tax Rates Are Correlated with Where Income
Is Reported, Report to the Committee on Finance, US Senate
(Washington, DC: GAO, August 2008) (available on the Web at
http://www.gao.gov/products/GAO-08-950), 46 pages
This report contains some interesting data on the effective tax rates (etrs) of large
corporations (those with total assets of $10 million or more) in the United States.
Using 2004 tax return data, the weighted average etr for such corporations with
positive us-source income was an estimated 25.2 percent. There was, however,
considerable variation in etrs across taxpayers. For example, one-third had rates of
10 percent or less, while one-quarter had rates over 50 percent. Large corporations
with foreign-source income had etrs on such income of only 4 percent. The low
etr is a function of the fact that us tax on foreign-source income is deferred until
repatriation and is only a residual amount determined after crediting any foreign
taxes.
us business activity is found to have increased in absolute terms over the period
from 1989 to 2004. Six separate measures of such activity are used: (1) sales, (2) value
added, (3) employment, (4) compensation, (5) physical assets, and (6) net income.
The report finds that 60 percent of business activity of us multinational corporations
remained in the United States. Finance and insurance had the lowest percentage of
such activity located abroad, while much larger percentages of manufacturing and
wholesale activity were located abroad. The report also confirms the findings of a
now considerable empirical literature that tax rates influence the amount of income
reported relative to the amount of activity located in a country. Countries with relatively low etrs were found to have income shares much larger than their shares of
three measures of business activity that are considered least affected by incomeshifting practices: (1) physical assets, (2) compensation, and (3) employment. Countries
with relatively high tax rates were found to have income shares much smaller than
their shares of those measures. The report notes that Canada and the United Kingdom
dominate all the measures of business activity other than income. With comparable
shares of income and business activity, China was a notable outlier for countries
with relatively low etrs. Japan was a notable outlier for countries with relatively
high etrs.
T.E.
current tax reading n 1049
Steven A. Dean, “The Incomplete Global Market for Tax Information”
(2008) vol. 49, no. 3 Boston College Law Review 605-72
The author develops an argument that he made in an article published last year.24
In the earlier article, he suggested that the United States could gain access to tax information held in tax havens by paying for it. In this article, Dean argues that the
existing structure for information exchange is incomplete in the sense that potentially
beneficial transactions do not take place. Most importantly, the existing structure only
permits barter transactions, in the form of the exchange of raw tax data, between the
tax administrations of two countries. A more complete market for information exchange would impose fewer constraints. For example, the tax administration of one
country could pay for specific information held by another. As an alternative to the
development of a more complete market for the exchange of tax information, Dean
argues that governments must consider the creation of a supranational tax infrastructure, which could facilitate the flow of information on a multilateral basis. This
initiative could be supported by certain amendments to substantive tax laws, which
would reduce the need for extraterritorial tax information. Given the Department
of Finance’s recent emphasis on tax information exchange agreements,25 Canadian
readers should find this article especially thought-provoking.
T.E.
Christopher H. Hanna, “The Real Value of Tax Deferral”
Florida Law Review (forthcoming)
The author, a legal academic at Southern Methodist University’s Deadman School
of Law, has written extensively on the subject of tax deferral and the time value of
money.26 In this article, Hanna makes the provocative argument that although the
subject of tax deferral has received considerable academic attention, it is decidedly of
secondary importance to large us corporate taxpayers. Income exclusions (or deductions providing the equivalent of exclusion) are valued much more highly because
they increase corporate income for financial accounting purposes, thereby increasing
earnings per share while reducing etrs. Tax deferral pales in comparison because,
for financial accounting purposes, it does not increase income or earnings per share.
24 Steven Dean, “Philosopher Kings and International Tax: A New Approach to Tax Havens, Tax
Flight, and International Tax Cooperation” (2007) vol. 58, no. 5 Hastings Law Journal 911-65.
25 Canada, Department of Finance, 2007 Budget, Tax Measures: Supplementary Information and
Notice of Ways and Means Motions, March 19, 2007, paragraph 31.
26 See, for example, Christopher H. Hanna, Comparative Income Tax Deferral: The United States
and Japan (The Hague: Kluwer Law International, 2000), reviewed in this feature (2001) vol. 49,
no. 3 Canadian Tax Journal 843-55, at 843-45. See also Christopher H. Hanna, “Demystifying
Tax Deferral” (1999) vol. 52, no. 2 SMU Law Review 383-422; and Christopher H. Hanna,
“The Virtual Reality of Eliminating Tax Deferral” (1995) vol. 12, no. 2 The American Journal of
Tax Policy 449-512.
1050 n canadian tax journal / revue fiscale canadienne
(2008) vol. 56, n o 4
The principal effect of tax deferral is increased cash flow, which is significant for
small and immature businesses.
T.E.
Karen C. Burke and Grayson M.P. McCouch, “Turning Slogans into
Tax Policy” (2008) vol. 27, no. 4 Virginia Tax Review 747-81
The authors of this article examine two prominent elements of the Bush administration’s tax-cutting agenda: repeal of the estate tax and reduction of the dividend tax
rate. They argue that “[t]hese seemingly disparate episodes reveal a common pattern
in the Administration’s portrayal of its proposals.”27 More specifically, Burke and
McCouch characterize the Bush administration’s approach as offering simplistic economic rationales supported by speculative argumentation and unrealistically optimistic
assumptions. Revenue costs and regressive distributional effects have been masked
by the use of populist slogans emphasizing fairness and economic opportunity.
Nonetheless, legislative outcomes, driven by budget constraints and interest-group
politics, have served to reduce the whole tax-cutting agenda to an exercise in politics
and ideology rather than an exercise in dispassionate tax policy making. The result
has been an unrealistic and unsustainable fiscal position that will require fundamental
tax reform driven by considerations of base broadening, revenue offsets, or both.
T.E.
(2008) vol. 66, no. 1 University of Toronto Faculty of Law Review 1-99
This issue consists of three papers written by students in the Faculty of Law of the
University of Toronto:
Sina Akbari, “Foreign Currency Considerations in Tax Law and Policy”;
Kimberly Brown, “Tax Treaty Shopping and the gaar: mil (Investments) s.a.
v. The Queen”; and
n Michael Pal, “The Supreme Court of Canada’s Approach to the Recovery of
Ultra Vires Taxes: At the Border of Private and Public Law.”
n
n
As the titles indicate, there is no particular organizing theme, other than the obvious fact that the papers focus broadly on the subject of Canadian tax law.
T.E.
Paolo M. Panteghini, Corporate Taxation in a Dynamic World
(Berlin: Springer-Verlag, 2007), 232 pages
This book is targeted at financial economists interested in how taxes affect business
decisions and strategies. It offers a real-option perspective in that the author explains
27 At 748.
current tax reading n 1051
how strategic decisions can be viewed as real options. Real options are widespread,
with 25 percent of us companies surveyed indicating that they incorporate real options when evaluating capital budgeting projects (to invest or divest).28 Many more
firms consider real options in an ad hoc manner when they apply standard capital
budgeting techniques. Because firms make sequential decisions over time (hence the
“dynamic” in the title of the book), they usually have an option (or the flexibility) to
delay, an option to abandon, an option to switch, and potential growth options. Options to delay are considered call options, while options to abandon are considered
put options.
Irreversibility and uncertainty are common to all investment analysis. Such risks
can be magnified in the presence of income taxation, and particularly by tax asymmetries. For example, Faig and Shum find that corporate income taxes are more
distortive when investments have a higher degree of irreversibility.29
This book examines the entrepreneurial decision of when to incorporate (chapter
2), the choice of organizational form (chapter 3), the tax treatment of debt financing
(chapter 4), and foreign direct investment and tax avoidance (chapter 5). Each chapter reviews and summarizes the major theoretical literature. The second half of the
book examines issues of tax policy, including corporate tax base options (chapter 6),
the choice between broad and narrow tax bases (chapter 7), the choice between riskadjusted and risk-free imputation rates (chapter 8), whether the tax authority should
offer full loss offset or no loss offset (chapter 9), and the choice between residencebased and source-based taxation (chapter 10). It also presents conclusions and topics
for future research (chapter 11). Many of the detailed quantitative results are presented in appendixes.
This book will be useful to graduate students in economics and finance who wish
to understand the theoretical underpinnings of well-known tax-planning techniques
and the role of legislation in a second-best world.
Amin M.
Craig Copeland, “IRA Assets and Contributions, 2007”
(2008) vol. 29, no. 9 EBRI Notes 2-9
This study examines trends in accumulation of individual retirement account (ira)
assets based on us Internal Revenue Service (irs) data on the distribution of assets
and contributions to iras by ira type. Types of iras include traditional (deductible and non-deductible) iras, Roth iras (non-deductible contributions and tax-free
withdrawals), and other employment-based programs.
28 John R. Graham and Campbell R. Harvey, “The Theory and Practice of Corporate Finance:
Evidence from the Field” (2001) vol. 60, no. 2 Journal of Financial Economics 187-243.
29 Miguel Faig and Pauline Shum, “Irreversible Investment and Endogenous Financing: An
Evaluation of the Corporate Tax Effects” (1999) vol. 43, no. 1 Journal of Monetary Economics
143-171.
1052 n canadian tax journal / revue fiscale canadienne
(2008) vol. 56, n o 4
ira growth was driven in large part by rollovers from other types of retirement
plans and not new contributions. As at December 31, 2007, Americans held $4.75 trillion in iras, $3.49 trillion in private-sector defined contribution (401(k)-type) plans,
and $2.33 trillion in private-sector defined benefit plans. Forty-seven percent of ira
assets were held in mutual funds, 38 percent in brokerage accounts, 8 percent in life
insurance companies, and 7 percent in banks and thrifts. While 90 percent of all ira
assets are held in traditional (taxable on withdrawal) iras (similar to registered retirement savings plans [rrsps] in Canada), most new contributions are going into Roth
(untaxed at withdrawal) iras (similar to tax-free savings accounts [tfsas] in Canada)
and other types of iras. This study could have meaningful implications for the popularity of tfsas in Canada and the associated tax expenditures.
Amin M.
Jennifer C. Huang, “Taxable and Tax-Deferred Investing: A Tax-Arbitrage
Approach” (2008) vol. 21, no. 5 Review of Financial Studies 2173-2207
The author analyzes an intertemporal portfolio problem with both taxable and
tax-deferred retirement savings accounts with the objective of maximizing after-tax
accumulation. Using a tax-arbitrage argument, she identifies conditions under
which the optimal location decision (where to place an asset) is separable from the
allocation decision (how much to allocate to each asset). Investors place highly taxed
assets in the tax-deferred account to maximize the tax benefit and adjust their taxable portfolios to achieve the optimal risk exposure. The author shows, inter alia,
how the two-account problem can be reduced to a taxable-account-only problem.
Amin M.
Benjamin Tal, The New Tax-Free Savings Account: How Popular Will It Be?
Consumer Watch Canada (Toronto: CIBC World Markets, September 11,
2008) (available on the Web at http://research.cibcwm.com/economic
_public/download/cwcda-080911.pdf ), 5 pages
This publication describes how tfsas work, how they compare with rrsps, how they
are perceived, their expected popularity, and how similar plans have fared in other
countries such as the United Kingdom. Canadians are expected to make much more
use of tfsas than was predicted by the federal government. Collectively, Canadians
will have $120 billion in annual contribution room. Within five years (by 2013),
Canadians are expected to have $115 billion in their tfsas, occupying just under
20 percent of their aggregate contribution room.30 The aggregate tax savings (and
the associated tax expenditure) is expected to be approximately $2 billion.
30 $115 billion / (5 years × $120 billion annual contribution room) = 19.16 percent.
current tax reading n 1053
Survey evidence suggests that the average contribution to a tfsa is projected to
be $2,010, with 25 percent of plan-holders maximizing their annual contribution
room and 42 percent holding balances of under $1,000. The expected popularity of
tfsas is based on the popularity of individual savings accounts (isas) in the United
Kingdom. Roth iras in the United States are not as flexible as tfsas, and therefore
their popularity is not thought to be indicative of the popularity of tfsas in Canada.
The takeup on isas is more likely to be predictive of the takeup on Canadian tfsas,
since they are equally versatile, and tfsas are more flexible.
The versatility of tfsas—including their freedom from any clawbacks—is expected
to attract a large number of Canadians, even though public awareness currently is not
very high. The study estimates that approximately 400,000 low-income Canadians
will switch some $2.5 billion from rrsps to tfsas over the next five years. Survey
results show tfsas appeal to taxpayers because withdrawals are tax-free, amounts
can be withdrawn at any time, withdrawn amounts can be recontributed, benefit
clawbacks are not affected, unused contribution room can be carried forward, and
contributors are not forced to withdraw amounts at age 71.
tfsas may end up being even more popular when the new tax-planning schemes
currently being presented at conferences and analyzed in journals become well
known and aggressively marketed. However, it is not clear that tsfas will result in
new savings by Canadians.
Amin M.
Grant Schellenberg and Yuri Ostrovsky, The Retirement Plans
and Expectations of Older Workers, 2007 General Social Survey
Report (Ottawa: Statistics Canada, September 9, 2008) catalogue
no. 11-008-X (available on the Web at http://www.statcan.gc.ca/
pub/11-008-x/2008002/article/10666-eng.pdf ), 24 pages
This report, which is based on annual survey data compiled by Statistics Canada,
reveals that about half of near retirees (those in the 45-59 age group) plan to retire
between ages 60 and 65; 22 percent plan to retire before age 60; 11 percent do not
intend to retire; and 14 percent do not know their retirement date. In comparison
with earlier surveys, the report suggests that Canadians are planning to work a little
longer than they previously expected.
Only six in ten near-retirees are certain that they will be able to retire when they
planned to—a figure that may be lower after the financial crisis of 2008. Most respondents had a positive outlook, with 62 percent reporting their expectations of
having adequate retirement income. Not surprisingly, the uncertainty was greater
when respondents perceived their savings to be inadequate. The report contains interesting information on savings and retirement expectations across demographic
characteristics such as gender, job tenure, marriage, and immigration. The economic and stock market meltdown will likely make Canadians work a little longer
and report relatively less optimistic attitudes about their planned retirement.
Amin M.
1054 n canadian tax journal / revue fiscale canadienne
(2008) vol. 56, n o 4
Grant Schellenberg and Yuri Ostrovsky, The Retirement Puzzle:
Sorting the Pieces, 2007 General Social Survey Report (Ottawa:
Statistics Canada, September 9, 2008) catalogue no. 11-008-X
(available on the Web at http://www.statcan.gc.ca/pub/
11-008-x/2008002/article/10667-eng.pdf ), 13 pages
This report examines how Canadians do their financial planning, the sources of
information they use, the advisers they consult, and how these choices vary by
household income and demographics.
Amin M.
Wendy Pyper, “RRSP Investments” (2008) vol. 9, no. 2
Perspectives on Labour and Income 5-11
The author describes who owns rrsps, what investments are held inside rrsps, how
the composition of holdings varies by age, how assets are allocated within registered
and non-registered plans, and how holdings are related to other assets such as those
held inside employer pension plans.
Amin M.
Stephen Curtis, “Transfer Pricing for Corporate Treasury
in the Multinational Enterprise” (2008) vol. 20, no. 2
Journal of Applied Corporate Finance 97-112
This article argues that transfer-pricing issues should not be relegated to the tax
department alone, but should be addressed by a well-integrated, multifunctional
management team that includes the treasury. Transfer-pricing implications can arise
whenever a payment crosses borders, whether it involves intercompany loans, purchase of a receivable, provision of a guarantee, factoring of a receivable, or provision
of a hedge. The author provides various numerical examples to illustrate relevant
tax and transfer-pricing concepts for tax planners and senior management. Transferpricing issues can have implications for the firm’s capital structure and cost of capital,
financing of cross-border acquisitions, capital budgeting, management of foreign
exchange and transactional risk, and portfolio and investment management.
Amin M.
Koffie Nassar, Corporate Income Tax Competition in the Caribbean,
IMF Working Paper no. 08/77 (Washington, DC: International
Monetary Fund, 2008), 22 pages
The impact of competition to cut corporate income tax rates is shown in the trends
of average etrs calculated for 15 Caribbean countries. The results confirm the erosion of the tax base. The resulting low tax rates are also shown to blunt tax policy
instruments such as accelerated depreciation, loss carryforward provisions, and tax
harmonization. The author concludes that countries should avoid extreme competition
current tax reading n 1055
in the form of tax holidays, and should rely more heavily on consumption taxes to
broaden the tax base.
Amin M.
Jean-Marc Suret, Labour-Sponsored Venture Capital Funds: Time for
a Reassessment, Economic Note (Montreal: Montreal Economic
Institute, 2008) (available on the Web at http://www.iedm.org/
uploaded/pdf/mai08_en.pdf ), 4 pages
This economic note examines the labour-sponsored venture capital corporation
(lsvcc) programs in contrast to other competing venture capital funds. The author
shows how pervasive lsvccs are, their historical returns, and their fiscal cost, and
examine whether they accomplish their stated objectives, whether they crowd out
other venture capital, and their governance.
Amin M.
Statistics Canada, Income in Canada 2006 (Ottawa: Statistics Canada,
2008) catalogue no. 75-202-X (available on the web at http://www
.statcan.gc.ca/pub/75-202-x/75-202-x2006000-eng.pdf ), 145 pages
This report offers a wealth of information on incomes—both pre-tax and after-tax—
broken down by province, industry, household type, and other characteristics. The
report is essential reading for anyone interested in estimating market size for products and services, a core component of most business plans.
Amin M.
Jennifer L. Brown and Linda K. Krull, “Stock Options, R & D, and the R & D
Tax Credit” (2008) vol. 83, no. 3 Accounting Review 705-34
Prior research has shown that firms reduce their research and development (r & d)
expenditures in order to meet earnings targets,31 while r & d tax credits increase
r & d spending. r & d tax credits offer a cash flow incentive for companies to undertake r & d, and they reduce the costs of reporting lower book income.32 Firms that
undertake large amounts of r & d also tend to grant their employees compensation
in the form of stock options. Stock option exercises by r & d employees can increase
r & d tax credits, since the intrinsic value at exercise is considered an opportunity
cost to the company and therefore is eligible for the credits. The Canadian experience with scientific research and experimental development (sr & ed) tax credits is
31 Sugata Roychowdhury, “Earnings Management Through Real Activities Manipulation” (2006)
vol. 42, no. 3 Journal of Accounting and Economics 335-70.
32 Harley E. Ryan and Roy A. Wiggins, “The Interactions Between R & D Investment Decisions
and Compensation Policy” (2002) vol. 31, no. 1 Financial Management 5-29.
1056 n canadian tax journal / revue fiscale canadienne
(2008) vol. 56, n o 4
similar, as described in the Alcatel case.33 In Alcatel, the taxpayer sought to have the
employment income generated by its stock option program for its employees involved in sr & ed counted as part of qualifying expenditures for the purpose of its
proxy method calculation of sr & ed expenditures. Thus, employee stock options
that are exercised by r & d employees can increase r & d tax credits without reducing reported earnings because the options are expensed at the date of grant, with no
further financial reporting consequences to the employer at the exercise date. The
authors find that by incorporating both r & d activities and the exercise of options
by r & d employees, firms reduce r & d spending by 0.46 percent of total assets to
avoid earnings decreases, while r & d tax credits generated by stock option exercises
offset the decreases by 16 percent on average and by up to 42 percent for a fully
taxable firm.
Amin M.
Li Jin and S.P. Kothari, “Effect of Personal Taxes on Managers’
Decisions To Sell Their Stock” (2008) vol. 46, no. 1 Journal
of Accounting and Economics 23-46
The authors find that (controlling for other determinants of their selling) ceos are
less likely to sell their vested equity as the tax burden increases. This lock-in effect
seems to dominate ceos’ desire to divest themselves of their employers’ stock and
hold a diversified portfolio.
Amin M.
Kirsten A. Cook, G. Ryan Huston, and Thomas C. Omer, “Earnings
Management Through Effective Tax Rates: The Effects of Tax-Planning
Investment and the Sarbanes-Oxley Act of 2002” (2008) vol. 25, no. 2
Contemporary Accounting Research 447-71
Prior research has shown that firms manage their earnings through changes in their
etrs, particularly between their third and fourth quarters.34 etrs are determined
by accounting rules—particularly the matching principle—and are often the last
accounting expense determined before earnings are reported. One of the components of etrs is the tax fees paid to auditors or independent tax advisers. This study
shows that changes in etrs relate to tax-planning strategies that include joint taxable and financial income effects. The study also examines the extent to which
33 Alcatel Canada Inc. v. The Queen, 2005 DTC 387 (TCC).
34 Dan S. Dhaliwal, Cristi A. Gleason, and Lillian F. Mills, “Last-Chance Earnings Management:
Using the Tax Expense To Meet Analysts’ Forecasts” (2004) vol. 21, no. 2 Contemporary
Accounting Research 431-59.
current tax reading n 1057
greater third-to-fourth-quarter etr reductions are associated with higher tax fees
paid to auditors for firms that would miss their consensus earnings forecasts absent
etr changes (relative to firms that would otherwise reach or exceed these income
goals).
The Sarbanes-Oxley Act (sox) requires firms to separately disclose any tax
consulting fees paid to their auditors. The study finds mixed evidence of the effectiveness of sox. For firms that would miss their earnings targets absent etr
changes, higher tax fees paid to auditors were found to be associated with greater
third-to-fourth-quarter etr reductions in the pre-sox period. This negative association persisted in the post-sox period, suggesting that sox may not have been
entirely effective. Firms that otherwise met their earnings targets—either before or
after sox—were not found to have any negative association between tax fees paid
and etr reductions.
Amin M.