Canadian Pacific Rail’s Hidden Competitive Advantage

CP Rail is really good at avoiding corporate taxes. Can it continue to do so going forward?

| More on:
The Motley Fool
You’re reading a free article with opinions that may differ from The Motley Fool’s premium investing services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn more

Investors in Canadian Pacific Rail (TSX:CP)(NYSE:CP) have been handsomely rewarded over the past five years, as shares are up more than 250% since the market’s big decline in 2008-09.

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.

More on Investing

Supermarket aisle with empty green shopping cart

$183 for Toilet Paper and Cups: Why We Love Costco Stock

"I literally went up there to get two things."

Read more »

A worker gives a business presentation.

TFSA Investors: 2 Top Stocks to Buy Before They Rally Any Further

Although plenty of top Canadian stocks have been rallying recently, these two still offer great value and are perfect for…

Read more »

growing plant shoots on stacked coins
Stocks for Beginners

3 TSX Stocks With High Dividend Yields

Are you looking for a great opportunity to bolster your portfolio? Here are three TSX stocks with high dividend yields.

Read more »

financial freedom sign
Stocks for Beginners

1st-Time Investors: 2 Cheap Canadian ETFs to Buy for Financial Freedom 

Investing for the first time but don’t know where to start? Here are two cheap Canadian ETFs that can grow…

Read more »

Money growing in soil , Business success concept.
Dividend Stocks

Got $4,000? 4 Simple TSX Stocks to Buy Right Now

The macroeconomic environment is tense but investing can be simple. Here are four stocks to buy now and book your…

Read more »

Oil pumps against sunset
Energy Stocks

2 Top Canadian Energy Stocks to Buy Offering Dividend Yields Above 6%

These two top Canadian energy stocks are excellent long-term investments and offer unbelievable dividend yields if you buy them today.

Read more »

Target. Stand out from the crowd

4 TSX Stocks I Own and Will Buy More of if They Fall

These are my four top choices of TSX stocks that may dip in the future, but will pay me back…

Read more »

Dollar symbol and Canadian flag on keyboard
Stocks for Beginners

The 2 Best Canadian Stocks for Beginners Right Now

Stock market beginners in Canada could kickstart their investing journey by buying these two stocks right now.

Read more »