Results have been particularly impressive over the last two years, ever since CP managed to woo former Canadian National Rail (TSX:CNR)(NYSE:CNI) CEO E. Hunter Harrision from retirement in 2012, aided by activist investor Bill Ackman.
While reading the 2013 annual report, I noticed a competitive advantage the company enjoys that I was never aware of. It has to do with the company’s preferential tax treatment, dating back from the birth of the firm in 1880. Essentially, the company signed a contract with the government of Canada that stated it would have to pay no income tax on earnings if the railway across the country was completed. CP finished the line, the Canadian government held up its end of the bargain, and the rest is history.
As the company has expanded, it still only technically enjoyed special tax treatment on that original line across the country. But still, it has still managed to keep taxes at virtually zero. Canadian Business took a look at CP Rail’s taxation history over the past decade, and found a company that avoided taxes at every turn.
Starting in 2009, the company borrowed $1.75 billion and used the money to over contribute to its pension plan. The capital was borrowed at low interest rates, and the over contribution to the pension plan reduced taxes considerably since the Canadian tax code allows these to go against tax owing. The company even enjoyed a tax refund of $39 million in 2009.
CP Rail was also lucky to have all sorts of tax credits to use right before it started enjoying success. The company amassed more than $800 million in credits during the early part of the 2000s, and has been using those to minimize taxes since. The company has indicated these credits are close to being exhausted, as 2013’s estimated tax bill came in at more than $31 million.
CP disputed various corporate and fuel taxes it was obligated to pay on its preferred line — the original cross-Canada line — and managed to get the case into court. And that’s even after the Canada Revenue Agency voiced its disproval. How many other companies would be able to pull off such a feat?
Over the last decade, the total tax savings have been immense. CP Rail has paid just $138 million in taxes, just 2% of its pre-tax profits for those years. Rival Canadian National Rail paid 19% over the same period, also an enviable rate. These tax savings have allowed CP Rail to invest in excess capacity, buy back stock, and lure Harrison out of retirement. Don’t underestimate the advantage enjoyed by CP’s preferential tax treatment.
Foolish bottom line
While it appears CP’s days of paying 2% taxes may be over, the company does have a history of preferential tax treatment and has demonstrated its ability to keep taxes down. This should continue to be an advantage for the company going forward. Even if CP’s employees only manage to shave a few percentage points off the company’s taxes, investors will still enjoy those extra profits.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.
Fool contributor Nelson Smith has no positions in any stock mentioned in this article. Share Advisor Canada has recommended shares of Canadian National.