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March 28, 2003 (Globe and Mail)

Thanks to a tax loophole, corporate crime does pay

Millions of Canadians struggling with the annual headache of filing their income tax returns will be flabbergasted by the answer to the following question. What do these three companies have in common: a chemical corporation fined $100,000 for dumping toxic effluent into a lake, a brokerage firm fined $500,000 for insider trading, and a manufacturer fined $75,000 for exposing employees to unsafe working conditions?

The answer is that not only have these companies been convicted of breaking the law, but each is a beneficiary of an indefensible loophole in Canada's income tax law, which allows businesses to treat virtually all fines and penalties as tax-deductible business expenses.

This absurd situation is the product of a Supreme Court of Canada decision in 1999 involving a numbered company, 65302 B.C. Inc., that was penalized for selling more eggs than it was legally entitled to sell under quota rules. Prior to 1999, Revenue Canada took the position that allowing fines and penalties to be deducted was against public policy because it would undermine the intent of thousands of federal, provincial, and municipal laws. Only harmless fines, such as parking tickets, could be deducted in the past, and only where the taxpayer could prove that the fine was unavoidable.

The Supreme Court's ruling held that fines and penalties levied for breaking the law are no different than any other costs incurred for the purpose of earning business income. Law professor David Duff of the University of Toronto describes the court's decision as a "radical" rewriting of Canadian tax law.

A recent Internet search reveals that dozens of accounting firms have enthusiastically told corporate clients of this unexpected windfall. One firm lists all kinds of fines and penalties, levied for unlawful activities, that may now be deducted from business income. Examples include fines for using transport trucks with excess weight or unsafe tires; providing unsafe working conditions or causing injuries to employees; penalties for pollution or other environmental damage; Securities Act violations such as insider trading; unsafe transportation of dangerous goods; and professional negligence by accountants or doctors. The list could be expanded to include price fixing, bid rigging, fraud, money laundering, and dozens of other activities. The only exceptions are fines for bribery and penalties levied under the Income Tax Act itself.

A conservative estimate is that this loophole is costing Canadians hundreds of millions of dollars in lost tax revenues every year, money that could be put to myriad good uses, such as health care, protecting the environment, etc. In effect, law-abiding taxpayers are subsidizing the unlawful activities of unethical or incompetent businesses -- an extraordinarily perverse outcome.

Fines and penalties are intended to punish and deter. Allowing fines and penalties to be deductible from income tax is like taking with one hand and giving back with the other, lessening the deterrent effect. The deductibility of fines and penalties undermines other laws by suggesting that illegal activities are a legitimate business practice.

There is a strong ethical argument that businesses should not be able to profit from wrongdoing. As a judge in an earlier Canadian tax-law case noted, the purpose of fines "is to punish a breach of the law by making penalties large enough to have an impact on the offender and serve as a warning to the wider community. There is not much point in making it hurt if the salve of deductibility is available to soothe the pain."

More than three years have passed since the Supreme Court of Canada's decision, which explicitly invited Parliament to address the issue. The court wrote that "Parliament may well be motivated to respond promptly and comprehensively to prohibit clearly and directly the deduction of all fines and penalties."

Unfortunately, there is no indication that the federal government plans to address this problem in the near future. In contrast, the United States amended its income tax laws more than 30 years ago to forbid the deduction of any fines or penalties arising from the violation of any law. Canada's position is also at odds with income tax laws in England, Australia, and other industrialized nations.

Federal Finance Minister John Manley learned the hard way that subsidizing hockey players and wealthy team owners is highly unpopular with the Canadian public. Surely subsidizing unlawful corporate activities is on even thinner ice. Ottawa should take the Supreme Court's hint and immediately close this egregious tax loophole.

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