The Economics of Offshore Trading Corporations

Recently there has been a huge outcry related to offshore income being collected in low or no tax jurisdictions.  There has been some moral angst attached to this outcry.  It is said that the tax savings are achieved at the expense of domestic taxpayers. 

First, there is no moral component to paying taxes.  You either owe what’s assessed or you don’t.  Cheats will be dealt with by either the tax or criminal courts.  If a taxpayer enters into a contract with its offshore subsidiary to collect offshore income in a foreign jurisdiction and, that is a legitimate legal obligation (and not a sham) then the only contentious issues are (a) if the legal obligation is real, (b) if the separate existence of the offshore entity is real and (c) if there is any inter company pricing between the domestic and its offshore subsidiary, that the pricing between them is fair. 

Tax is just another expenditure for companies.  Optimizing tax is as important as optimizing purchases, salaries or other costs.  Increased taxation hurts reinvestment of resources in capital equipment, inventory and accounts receivable. Reinvestment of after tax earnings means more jobs.  If excess funds are paid out to shareholders then Canada receives the tax on these dividends and the shareholder’s net after tax income is either spent in the economy or contributed to the economy as additional investment.

Most OECD countries allow after tax earnings of offshore companies to be repatriated to the domestic parent free of tax.  The only country of any significance that does not conform to the norm is the US.  The US charges a tax of 35% of repatriated offshore income.  If, for example, the offshore company pays tax at the rate of 35%, then the total tax load for repatriated income would be about 70%.  This has caused US companies to hold about $1 trillion offshore instead of repatriating it to the US with resulting harm to the recovery of the US economy.

Most tax programs are there because the government wants to reward or subsidize certain behavior.  Depletion allowance reward mining and petroleum companies because Canada is a raw material exporter and rewarding this sector is a subsidization of the price of the product.  A tax credit for charitable donations is a subsidization of the charities sector of the economy.  Allowing a credit for medical expenses is a subsidization of the health industry.  And so on. Canada is a small trading country.  Canadian companies need to export to larger markets.  The subsidization of offshore trading companies makes Canadian companies more price competitive.  Lastly, I would argue that the subsidy is not much of a subsidy but rather a timing adjustment in collecting taxes.  This is because dividends from the Canadian parent will be fully taxable in the hands of its shareholders.  To the extent that the Canadian parent can delay taxation by simply holding the funds is also true for the domestic Canadian corporation. 

The huge outcry is mostly political.  No one in government seriously believes that the US model would be better for Canada.  If this were the case many Canadian companies would simply hold offshore profits offshore or leave Canada as its main taxing jurisdiction.