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The tax deductibility of environmental fines

Petition

December 3, 2003

Auditor General
Office of the Auditor General of Canada and the Commissioner of the Environment and Sustainable Development
Attention: PETITIONS
240 Sparks Street
Ottawa, Ontario
K1A 0G6 Canada

Dear Auditor General and Commissioner of Environment and Sustainable Development

Re: The tax deductibility of environmental (and other) fines and penalties

Please consider this a formal petition pursuant to the provisions of s. 22 of the Auditor General Act requiring the Commissioner to submit citizen petitions on environmental matters to the appropriate federal Minister(s).

Background

Because of a Supreme Court of Canada decision in 1999, businesses operating in Canada are now able to deduct fines and penalties levied for violating environmental laws (and indeed virtually all laws and regulations) from their business income for tax purposes. The Court's decision was based on the fact that the Income Tax Act does not explicitly state that such fines cannot be deducted from business income. Law professor David Duff of the University of Toronto describes the court's decision as a "radical” rewriting of Canadian tax law. Prior to this court decision, Revenue Canada had a policy that did not allow such fines and penalties to be deducted. Subsequent to the Court's decision, a new policy was issued acknowledging that such fines and penalties can be deducted.

The tax deductibility of fines and penalties causes a serious reduction in the effectiveness of Canada's environmental laws in deterring violations. Knowing that fines and penalties are deductible encourages businesses to regard them as the mere cost of doing business. As fines and penalties grow larger, the cost to Canadian taxpayers, both economically and environmentally, continues to grow.

For example, several major shipping companies were recently fined $125,000 each for violating the pollution provisions of the Canada Shipping Act by spilling oil into the ocean. However, the fact that these fines can subsequently be counted as a tax-deductible business expense substantially reduces their effectiveness. Similarly, CBC-TV's Disclosure program recently aired a feature on this topic, indicating that Shell and Nova Chemicals admitted deducting large fines from their business income, fines that were incurred for chemical releases that harmed both human health and the environment (in Ontario's Chemical Valley). The transcript is attached* (from the program that aired November 18, 2003).

A vital element of achieving sustainability is ensuring that economic and environmental goals and policies are consistent. To allow businesses to deduct fines and penalties levied against them for environmental offences sends the wrong signal to Canadian companies. As other industrialized nations (including Canada's major trading partners) have already recognized, environmental fines and penalties should not be deductible from business income.

I note that the Honourable Minister of Finance John Manley was asked about this issue during Question Period earlier this year by Opposition M.P. Pat Martin and responded that the courts had spoken on this matter. Here is the excerpt:

Friday, February 7, 2003
Mr. Pat Martin (Winnipeg Centre, NDP): Mr. Speaker, tax season is here again and the government has still done nothing to plug the outrageous tax loophole where businesses can deduct fines as a business expense. The minister said that most of the claims were denied but he knows full well that they succeed on appeal and that is why the Supreme Court said that Parliament must change the act to deal with the issue. Why will the government not amend the Income Tax Act to ensure that no one in the country will ever again get a tax deduction for breaking the law?

Hon. John Manley (Deputy Prime Minister and Minister of Finance, Lib.): Mr. Speaker, as the hon. member acknowledges, this is a matter that has been dealt with by the courts in a way that reflects the fact that there may be circumstances that sometimes would result in the courts deeming that an expenditure of this nature is properly deductible. That is something that the courts have decided.

The Minister's response is inaccurate and misleading. In fact, in its reasons for decision in the 65302 British Columbia Ltd. case, the Supreme Court of Canada explicitly invited Parliament to address this issue by amending the Income Tax Act. 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, Parliament has not yet done so, putting Canada at odds with nations like the United States, England, and Australia where businesses are not allowed to use environmental fines as a deduction to reduce their income for tax purposes.

I would like to draw your attention to five important background documents:

1. a copy of my essay published in the Globe and Mail on March 28, 2003 called "Thanks to a tax loophole, corporate crime does pay,” Attached, and also available on-line at: http://www.globeandmail.com/servlet/ArticleNews/TPStory/LAC/20030328/CODEDUCT/Comment/Idx

2. an article by University of Toronto law professor David Duff, "Deductibility of Fines and Penalties under the Income Tax Act: Public Policy, Statutory Interpretation and the Scheme of the Act in 656302 B.C. Ltd.” (2001), 34 Canadian Business Law Journal 336-90. Attached.*

3. the Supreme Court of Canada's 1999 decision in the 65302 British Columbia Ltd. case. 65302 British Columbia Ltd. v. Canada [1999] 3 S.C.R. 804.
   Available on-line at: http://www.lexum.umontreal.ca/csc-scc/en/pub/1999/vol3/html/1999scr3_0804.html

4. the Canada Customs and Revenue Agency Interpretation Bulletin on "Deductibility of Fines and Penalties” NO.: IT-104R3, DATE: August 9, 2002
   Available on-line: http://www.ccra-adrc.gc.ca/E/pub/tp/it104r3/it104r3-e.html

5. the transcript from CBC-TV's Disclosure program, which aired on November 18, 2003 (attached).*

Request

I would like the Minister of Finance to respond to the following questions:

How much is this loophole costing Canadian taxpayers each year?

When, if ever, since the change in law in 1999 has a business been denied a deduction by the Canada Customs and Revenue Agency for "egregious” fines and penalties?

Will the Minister introduce amendments to the Income Tax Act to prohibit businesses from deducting all fines and penalties, including environmental fines and penalties, from their income for tax purposes?

If so, when?

If not, why not?

If not, why is Canada taking a different position than its major trading partners (the U.S., the U.K., and Australia) on this issue?

I would also like the Minister of Environment, Minister of Natural Resources, Minister of Transport, and the Minister of Revenue to express their positions on this issue in light of both the revenue loss to the federal government and the diminished deterrent effect of fines and penalties.

My position is that the federal government should move swiftly to close this indefensible loophole by amending the Income Tax Act to prohibit the deduction of any fines and penalties from business income, for the compelling public policy reasons identified earlier.

Conclusion

Thank you for your time in considering this petition. I look forward to receiving the government's response.

Respectfully,

[Original signed by David R. Boyd]

David R. Boyd

Senior Associate
POLIS Project on Ecological Governance
Eco-Research Chair of Environmental Law and Policy
University of Victoria

Adjunct Professor
School of Resource and Environmental Management
Simon Fraser University

1321 Mackinnon Road, RR1
Pender Island, BC V0N 2M1

Tel: 250-629-9984
Email: drboyd@uvic.ca

*[attachments not posted]

Appendix 1: Article from the Globe and Mail, Friday March 28, 2003, p. A17

Thanks to a tax loophole, corporate crime does pay

DAVID R. BOYD
Globe and Mail
Friday, March 28, 2003

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.

David R. Boyd is an environmental lawyer and an adjunct professor with the School of Resource and Environmental Management at Simon Fraser University.

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Minister's Response: Environment Canada

April 19, 2004

Mr. David R. Boyd
Senior Associate
POLIS Project on Ecological Governance
Eco-Research Chair of Environmental Law and Policy
University of Victoria
1321 Mackinnon Road, R.R. 1
Pender Island BC
V0N 2M1

Dear Mr. Boyd:

I am writing to provide Environment Canada's response to your environmental petition no. 98 to the Commissioner of the Environment and Sustainable Development, concerning the income tax deductibility of environmental fines and penalties. Your petition was received in the Department on January 8.

Income taxation matters are the responsibility of Finance Canada. I note that the petition was also sent to my colleague, the Honourable Ralph Goodale, Minister of Finance. I understand that the Minister of Finance will be responding to your petition in the near future.

As you may be aware, the March 23 Federal Budget proposed to amend the income tax legislation to deny the deductibility of any fine or penalty imposed by law. This amendment will apply to fines and penalties imposed after March 22, 2004.

Thank you for your interest in this matter.

Yours sincerely,

[Original signed by David Anderson, Minister of the Environment]

David Anderson, P.C., M.P.

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Minister's Response: Finance Canada—Department of

May 12, 2004

Mr. David R. Boyd
Senior Associate
POLIS Project on Ecological Law and Policy
Adjunct Professor
School of Resource and Environment Management
Simon Fraser University
1321 Mackinnon Road, RR1
Pender Island, BC
V0N 2M1

Re: Environmental petition No. 98

Dear Mr. Boyd:

Further to my acknowledgement letter of January 21, 2004, I am pleased to provide you with a response to the petition (Petition No. 98) that you submitted through the Commissioner of the Environment and Sustainable Development. This petition was also sent to my colleagues, the Ministers of Transport, Natural Resources and the Environment. My response outlines the Government of Canada's position on this matter.

In this petition, you have expressed the view that the deductibility of fines and penalties for income tax purposes is not appropriate. In particular, you have asked me, in my capacity as the Minister of Finance, to introduce amendments to the Income Tax Act to specifically prohibit businesses from deducting all fines and penalties, including environmental fines and penalties, from their income for tax purposes.

As you are aware, the Income Tax Act generally permits a taxpayer to deduct, in computing income from a business or property, expenses incurred for the purpose of earning that income. Recent jurisprudence has held that deductibility generally extends to fines and penalties incurred in the ordinary course of earning income, unless the underlying action or omission was so egregious or repulsive that the fine or penalty could not reasonably be considered to have had an income-earning purpose.

Many countries with similar income tax systems to Canada rely either on a statutory prohibition to the deductibility of fines and penalties or on jurisprudence that provides the same result. It is generally recognized that allowing a deduction for a fine or penalty that has been imposed in respect of a particular statute reduces the disincentive to engage in that activity. Generally, therefore, such a deduction can be viewed as being contrary to overall public policy objectives.

In order to provide certainty in this area of the tax law, and to achieve an appropriate result, the 2004 Budget has proposed to deny the deductibility of fines and penalties imposed by a government, government agency, regulator, court or other tribunal, or any other person with statutory authority to levy those fines or penalties. This change to the Income Tax Act will ensure that businesses are unable to obtain an income tax deduction for fines and penalties imposed after March 22, 2004.

Thank you for providing me this opportunity to respond to your concerns.

Yours sincerely,

[Original signed by Ralph Goodale, Minister of Finance]

Ralph Goodale

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Minister's Response: Natural Resources Canada

May 5, 2004

Mr. David R. Boyd, Senior Associate
POLIS Project on Ecological Law and Policy
Adjunct Professor
School of Resource and Environment Management
Simon Fraser University
1321 Mackinnon Road, R.R. #1
Pender Island, British Columbia
V0N 2M1

Dear Mr. Boyd:

Thank you for your petition dated December 3, 2003, addressed to me and my colleagues, the ministers of the Environment, Finance and Transport Canada. In your petition, you posed questions under the Auditor General Act on the topic of the "tax deductibility of environmental (and other) fines and penalties".

Due to the number and the complexity of the issues being addressed by the petition, four departments have collaborated and prepared a consolidated response. My colleague, the Honourable Ralph E. Goodale, Minister of Finance, will be providing you with the Government's response to the petition.

Again, thank you for your interest in this important matter and for your petition.

Yours sincerely,

[Original signed by R. John Efford, Minister of Natural Resources Canada]

The Honourable R. John Efford, P.C., M.P.

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Minister's Response: Transport Canada

May 4, 2004

Mr. David R. Boyd
Eco-Research Chair of Environmental Law and Policy
University of Victoria
1321 Mackinnon Road, R.R. 1
Pender Island, British Columbia
V0N 2M1

Dear Mr. Boyd:

I am writing in response to your letter to the Commissioner of the Environment and Sustainable Development of Canada (CESD), which was forwarded to the Minister of Transport on January 7, 2004, as an environmental petition (petition #98), pursuant to section 22 of the Auditor General Act, concerning the income tax deductibility of environmental fines and penalties. As Parliamentary Secretary to the Minister of Transport with a special emphasis on Transport and the Environment, the Honourable Tony Valeri has asked me to respond on his behalf.

I am pleased to note that you have brought the petition to the attention of the Honourable Ralph Goodale, Minister of Finance, for his consideration as income taxation matters are the responsibility of Finance Canada.

As you may be aware, the March 23, 2004 Federal Budget proposed to amend the income tax legislation to deny the deductibility of any fine or penalty imposed by law. This amendment will apply to fines and penalties imposed after March 22, 2004.

I understand that the Minister of Finance will be responding to your petition in the near future and I trust that he will provide you with the information that you are seeking.

Yours sincerely,

[Original signed by Jim Karygiannis, Parliamentary Secretary to the Minister of Transport]

Hon. Jim Karygiannis, P.C., M.P.