There is nothing wrong a corporation minimizing its tax burden. As long as its activities are legal, avoiding the tax man is part of a company’s fiduciary responsibility to shareholders.
But a recent investigative report by Canadian Business found that some Canadian companies take tax avoidance to new extremes. This has serious implications for investors. If the government either closes some loopholes, or finds that these companies have been cheating their tax bill, then these companies’ earnings could take a serious hit.
The top three (or bottom three) companies are as follows:
3. Manitoba Telecom Services
Over the past 10 years, Manitoba Telecom Services (TSX:MTB) earned $2.4 billion in pre-tax income, but paid only $100 million in cash taxes. MTS avoids taxes because it has a very large amount of tax loss carry-forwards. The company was credited with plenty of carry-forwards when it was privatized in 1997 and when it bought Allstream in 2004. MTS also is able to write off its capital investments very quickly, something not uncommon for telecom firms.
This has been great news for shareholders, but also has created considerable uncertainty. The Canada Revenue Agency has been auditing MTS, and in April 2013 “would not accept the Company’s proposal to settle all outstanding audit issues.” MTS said in its annual report that “it is not possible to quantify any potential impact at this time.”
2. Canadian Pacific
With $7.7 billion in pre-tax income but only $139 million in cash taxes over the past 10 years, Canadian Pacific (TSX:CP)(NYSE:CP) earns the silver medal on this list. CP’s secret sauce is a treaty signed way back in the 19th century, which stated that the company shall be forever free from taxation. That treaty hasn’t gotten the company entirely off the hook, but CP has used other methods. The railroad has used extensive tax loss carry-forwards, and also got favourable treatment from over-contributing to its pension plan.
Like MTS, CP is currently tussling with the CRA over its tax bill. Shareholders, be warned.
1. First Capital Realty
The gold medal, with only $22 million in taxes from $1.8 billion in profits over the past decade, goes to First Capital Realty (TSX:FCR). Like the two companies above, First Capital takes advantage of tax loss carry-forwards. But there are a couple other neat tricks.
First, as a real estate company, First Capital must report income when the value of its properties rises. But it doesn’t have to pay cash until the properties are sold. It clearly pays to be a long-term investor.
Second, when the company issues debt to buy new properties, interest isn’t paid in cash. It’s paid in shares – but the payments are still tax-deductible. This means that the company can effectively issue equity while also getting a tax deduction.
Foolish bottom line
Tax issues are often overlooked by investors. In fact many financial metrics, such as gross profit, EBIT and EBITDA, ignore tax altogether.
But taxes can create significant advantages for companies like the ones above, and can create real uncertainties too. It’s something that investors should always be aware of, even when it gets complicated.