Corporate Finance, 101

Last week I promised a rant to prove that I am not a socialist.

Let me state from the outset that I understand that a significant portion of the consolidated revenue fund (CRF) is obtained from the collection of corporate taxes.

As a precondition of my position, please note that I believe that corporate investment is the solution to many of Canada's problems, most notably environmental degradation and widespread poverty. Canada should do everything in its power to encourage responsible investment in Canada where it can have a say on how that money is invested. 40 Billion here is better than 40 billion in China where laws don't matter that much.

Corporations are often seen as the scapegoat to the country's problems. It is just so easy to blame the corporations for the pollution, for the layoffs, for the toxics in our blood...well, YOU own them. YOU buy their products. YOUR pension plan screams bloody murder when profits go down by an eighth of a point. Corporations aren't the problem. YOU ARE FOR INVESTING IN THEM!

Yes, there are bad corporations. There are also bad people. They are not all the same. The ones that are bad, should pay for it - just like murderers go to jail.

That said, I am steadfast in my conviction that corporations should pay no taxes whatsoever: Not a dime. I can hum and haw about what kind of corporations shouldn't pay taxes, but ultimately, companies that have more capital will create more wealth. If they create more wealth, we can tax it later. Corporations are the golden goose because they create jobs - and income taxes remain the primary source for the CRF. Keep a company liquid longer, and more people will have work. Period. If they decide to pay it out to their shareholders instead of re-investing it into their company, we tax the shareholder directly.

A corporation is a legal person. A person who is controlled by hundreds, thousands, if not millions of other people. Sometimes they are controlled by one person. Special tax rules apply to a corporation depending on its size, but ultimately, the rule is that a corporation has revenue, expenses, losses and profits - and it pays taxes on those in a similar way that we do.

Except, nobody owns me. If I was to give all of my after tax income away to my parents who "owned" me, should they have to pay taxes on it again? Nope, and they don't- it would be considered a windfall or a gift.

Shareholders pay taxes on their income. For example, I am a lawyer who writes restaurant reviews and from time to time buys and sells secured shares in Canadian companies. When I get a dividend check from a company, I pay taxes on that income - because the purpose for that investment was to make money. My parents didn't make me to make money- it was apparently to make me in their image...or something.

Right now, at tax time, the corporation gets dinged, I get dinged, and then (if the stock goes up in value) I get dinged again when I sell the shares (at a separate and special rate, might I add.) Remembering that I already paid taxes on the money I use to buy the shares, right?

Not the best way to attract investment in Canada. Not the best way to manage revenue either.

There are books written on how corporations avoid taxes, but they all say the same thing - corporations hold their assets in the way which is most effective and mitigating, reducing, delaying or prolonging taxation. They don't avoid anything.

If corporations didn't pay taxes, they would be in an excellent position to make even more money for their shareholders. They would do so by re-investing that untaxed capital and as a result, their SHARE value will go up. What I buy for $4 today will be worth $8 in two years, and so on...as the company acquires assets, ideas, employees and a market - they will continue to reinvest that capital and build wealth. When it ultimately gets paid to me through dividends or when I sell my share- I have the entirety of the tax burden. I entered into the company to make money, I absorb the tax consequences, and I alone am responsible. When I leave the company, I pay the taxes.

In the meantime, the corporate bottom line will remain in great shape. Having saved 22% or more a year, the company can continue to acquire, invest, invent and grow. Employing more Canadians (who will pay income taxes) and who will buy more sprockets. The market feeds itself.

The immediate effect on the CRF (consolidated revenue fund) will be momentary as the corporate taxes are replaced over time with income taxes and capital gains taxes. This plan of mine is not a tax cutting scheme at all. It is a tax deferral scheme- in that no taxes are incurred until the owners get paid. By taxing it at time T1, by the time the income gets to the share holder at T2, the value is lower, and as a result, the income tax or capital gains tax is lower. The net effect is zero, but for the interest which accrues between T1 and T2.

It is also my choice as an investor to use those gains (or losses) as my own assets. If I want to hold the investment in the company forever, that is my choice, and the government doesn't have the right to encroach on my income until it actually makes ME money. That is the principle of taxation lost on revenue seekers in government.

Then, someone in Europe will go "Holy Cow! We can invest in Canada and pay no taxes, take advantage of free health care and one of the most educated workforces in the world which is on the doorstep of our largest market?"

The caveat, of course, is that the capital can't leave the country. If they try to repatriate it somewhere else, the whole model falls apart. The condition is that companies can only benefit from this tax holiday if they are Canadian owned and publicly traded. Companies already have subsidiaries in Canada now to take advantage of all kinds of programs, this isn't that much of a stretch considering the benefit. in 2007, most companies don't really care who their shareholders are, either.

Corporate taxes represent many things. For starters, they represent a revenue source for accountants and lawyers across the country who openly take advantage of the complexity at the peril of their corporate clients, and subsequently, their shareholders. The relatively high rate of corporate income taxation is sympton of a a bigger problem- a loophole driven system which has four principles which are routinely twisted beyond recognition:

1) Income is the difference between revenue and expenses;

2) Allowable expenses are categorized, not listed;

3) Corproations are a mechanism to increase revenue; and

4) The Act is to be interpretted narrowly.

If the income tax act was limited to twelve sections on eight pages, over 10,000 employees at the CRA and Finance and 18,000 part time employees at tax time would have to find new work.

Shocking how they routinely advise Ministers against simplification.