Canada's Offshore Pension Scandal?

Zach Dubinsky and Valérie Ouellet of CBC News report, Millions of Canadians have pension money offshore — without knowing it:
Palm-fringed islands, balmy weather, luxury yachts moored in azure waters — offshore tax havens conjure up a wonderland for the well-heeled and their wealth.

But a CBC investigation based on the Paradise Papers leak has found that millions of ordinary Canadians also have an interest in money parked in tax havens — almost certainly without knowing it.

Seven of the country's so-called Big 8 pension funds, representing more than 25 million workers, have used tax havens as they invest Canadians' retirement savings, according to records in the huge leak of offshore financial documents made public last month.

This revelation underscores a delicate quandary. On the one hand, pension funds need to make enough money to ensure they can pay benefits to an aging population, and using tax havens for investments abroad can help the bottom line. But it raises questions about whether Canadians' retirement money is underwriting an offshore industry that undermines tax fairness and transparency.

The pensions' high-profile offshore dealings include the 407 Highway north of Toronto, which the Canada Pension Plan Investment Board bought a 40 per cent stake in — partly through an entity in Bermuda. Or the high-speed rail line from London, England, to the Channel Tunnel, which a pair of Canadian pension funds owned until earlier this year via a shell company in Jersey, a tax haven in the Channel Islands.

None of the pension plans would say exactly how much of their revenue is generated by investments through tax havens. In response to questions from CBC, almost all of them pointed out that Canada doesn't tax pension plans on their investment income, so their use of tax havens makes no difference to federal or provincial government coffers.

But other countries have different tax rules, and some Canadian pension funds acknowledged that offshore investment structures help them legally minimize their tax burdens abroad. Some even said it's their duty to do so in order to maximize savings available for retirees.

"We structure our foreign investments to maximize the after-tax investment returns available to CPP contributors and beneficiaries," the Canada Pension Plan Investment Board (CPPIB) said in a statement, noting that 85 per cent of its assets are abroad.

"CPPIB has a responsibility to over 20 million contributors and beneficiaries to seek a maximum rate of return to help sustain the CPP fund for multiple generations."

A former top pension executive said that while Canada's major retirement funds used to invest nearly all of their assets domestically, it would be impossible to do so today and still generate the profits needed to pay decent benefits.

"Thirty years ago, when all investments were in Canada by those pension plans, they didn't need to structure things through the Bahamas," said Jim Leech, CEO of the Ontario Teachers Pension Plan from 2007 to 2013. "We can go back to that, and the pensioners will get half their pension."

'Absolutely unacceptable'

That doesn't resonate with Hassan Yussuff, the president of the Canadian Labour Congress and one of Canada's most prominent voices for workers. Yussuff said Canadians' pensions simply shouldn't be invested in tax havens because of their notoriety as epicentres for tax dodging.

"We want the tax system here to have credibility," he said. "It's absolutely unacceptable in terms of what we expect of pension funds, in terms of their ethical investment."

The federal government has repeatedly declared that it wants to make the tax system more fair — in part, the Finance Department says on its website, by efforts "to stop the use of tax havens."

Yussuff said it's contradictory to keep pledging tax fairness and transparency while, simultaneously, the CPP — the federal pension plan — is enmeshed in some of the very tax havens that are the targets of tax fairness and transparency campaigns.

CBC's investigation found numerous examples of major Canadian pension funds using or investing in tax havens. Here's a sample:
  • If you contribute to CPP, or work for the federal government or the provincial public service in B.C., then you have a stake in Chile's largest electricity company. That's thanks to a $1.55-billion US joint takeover by the CPP Investment Board, the federal Public Sector Pension Investment Board, the B.C. Investment Management Corp. and a private sector company back in 2006. The transaction was routed through a corporation set up in zero-tax Bermuda, because the island territory was "tax neutral" for all the investors.
  • The Ontario Teachers Pension Plan and OMERS, the pension fund for hundreds of thousands of Ontario municipal workers, owned the High Speed 1 rail line in Britain until September, via a holding company also incorporated in Jersey. Neither pension fund would say why they did it that way.
  • The Caisse de dépôt et placement du Québec, which invests the Quebec provincial pension plan as well as the pensions of many provincial and municipal employees, put money into a number of Cayman Islands companies in order to invest in North American financial markets and in an Israeli-managed venture capital fund. The Caisse said in a detailed statement that it obtained "no tax benefit" from the North American investments. The Israeli fund, it said, is one of many "regularly constituted" in certain tax-haven jurisdictions because of their efficient corporate laws, dependable legal systems and "a neutral taxation policy."
$1 trillion in assets

Canada's biggest pension funds have grown significantly in recent years in order to pay benefits to an increasing proportion of retirees. The Big 8 plans alone are now worth more than $1 trillion, and agencies like the CPP Investment Board, Ontario Teachers and Quebec's Caisse are among the biggest institutional investors in the world.

Couple that demographic trend with historically low interest rates on government and corporate bonds in Canada since the 2008 financial crisis, and pension fund managers have had to look outside the country to find investment returns to sustain retirees' benefits, analysts say.

And that has often meant using tax havens.

Fund managers "must fund these pensions in a very difficult economic context," said Chris Roberts, director of economic policy at the Canadian Labour Congress.

He said that as a result, a lot of CLC's members have "conflicted feelings about what their pension funds are doing, on the one hand, but also feeling like, 'Is my pension going to be there for me as well?'"
In its article, the CBC states the following major Canadian pension fund management bodies are mentioned in the Paradise Papers:
  • Canada Pension Plan Investment Board
  • Caisse de dépôt et placement du Québec
  • Ontario Teachers Pension Plan
  • Ontario Municipal Employees Retirement System (OMERS)
  • Public Sector Pension Investment Board (PSP Investments)
  • British Columbia Investment Management Corporation
  • Alberta Investment Management Corporation
I recently covered the Grand Cayman pension scam where I stated these investigative reports linking public pensions to offshore tax havens are grossly misleading and full of disinformation.

As I stated in that comment, using offshore structures to minimize tax bills is not only in the best interest of hedge fund and private equity managers, but also in the best interest of public pensions and their beneficiaries.

I also stated the following:
Earlier this year, the Caisse's CEO, Michael Sabia, had to defend the Caisse's investments in offshore tax havens (they doubled from $15 billion in 2013 to over $30 billion now). Why the need to do this, especially since it's not in the best interest of the province to remove those assets from these tax havens.

No doubt, we need lower fees, more fee transparency and better reporting information linking fees to returns, but spreading misinformation and lies about offshore tax havens isn't helpful and most certainly isn't in the best interests of the plan's sponsors and beneficiaries (or taxpayers).
Keep in mind, we are talking about legal tax minimizing here, not tax evasion. Three years ago, PSP Investments did run into trouble with German tax authorities for using a very elaborate tax scheme to avoid paying taxes but that issue was resolved amicably. Pushing the enveloppe too far isn't in anyone's best interest.

CPPIB's satement is right: "We structure our foreign investments to maximize the after-tax investment returns available to CPP contributors and beneficiaries." That is their job, part of their mandate to maximize returns without taking undue risks.

Again, people need to understand the governance and mandate of Canada's large pensions. They're not an extension of the federal government, they're independent entities that have a clear mission and need to focus 100 percent of their attention on delivering on that mission.

Let me be blunt. If they paid full taxes on their foreign holdings and didn't minimize taxes as much as possible using all necessary legal means, they wouldn't be fulfilling their mandate, they'd actually be violating it.

Canada's public pensions aren't charities. They're running very sophisticated operations investing across public and private markets all over the world. They do so by minimizing internal costs and maximizing after-tax returns so Canadians can retire with dignity and security and not see their contribution rate go up or benefits slashed.

And Jim Leech is right: "Thirty years ago, when all investments were in Canada by those pension plans, they didn't need to structure things through the Bahamas. We can go back to that, and the pensioners will get half their pension" (he was exaggerating to make a point, see update at end).

There are no free lunches in economics or pensions. If you want to divest from something, you need to invest elsewhere to make up the return. If you want to just invest in Canada, you need to hike the contribution rate and cut benefits. Are we willing to accept the consequences of such ridiculous policy decisions?

With all due respect to Hassan Yussuff, the president of the Canadian Labour Congress, he's out to lunch when it comes to this issue. He's wrong to go after our large public pensions for doing their job, and he doesn't understand the consequences of what he's asking for.

"We want the tax system here to have credibility," he said. "It's absolutely unacceptable in terms of what we expect of pension funds, in terms of their ethical investment."

What is unacceptable is that some very big crooks are getting away with murder in Canada dodging big taxes using questionable tax schemes and the Canada Revenue Agency is going after mom and pop shops while ignoring a much more perverse problem in our society.

How do I know this? Because my first job out of McGill was consulting the then (1998) Special Investigations department at Revenue Canada (that's what it was called back then) to estimate the size of white collar fraud in our country.

The department was grossly under-staffed (it still is) and even though it had some of the very best forensic accountants in the country, they were only able to pursue a fraction of the cases they worked on and most offenders got away with a low fine (and I'm talking millions in each fraud case).

When it comes to tax evasion, Canada isn't the United States where they can throw you in jail for a very long time, and unfortunately, the crooks know this and use it to their advantage.

My advice to Mr. Yussuff and the CBC is focus your attention on covering tax stories that really matter, not our large Canadian pensions which are doing their job and fulfilling their mandate.

Below, the CBC reports the Canada Revenue Agency (CRA) is accused of targeting vulnerable people and failing to answer millions of phone calls. Add to this that most CRA convictions cited by government are not for offshore tax evasion, and you can't understand why many Canadians feel frustrated with our tax collectors (to be fair to the CRA, they are grossly under-staffed and overworked).

Still, don't confuse what Canada's large pensions are doing using offshore tax havens to legally maximize after-tax returns with what crooks and even some big business people are doing to evade or push the enveloppe of tax minimization to its limits. I think it's important to make a distinction because what our large pensions are doing benefit us all, including taxpayers and the federal and provincial governments.

Update: Malcolm Hamilton, a retired actuary shared this with me after reading this comment:
I don't understand how pensioners will lose half of their pensions if pension plans are prevented from organizing their foreign investments to minimize tax.

Personally, I have no objection to pension plans structuring their investments to minimize tax. If this can be done legally, and I'm sure than it can, fiduciaries have a duty to do so.

However, the cost of sub-optimal tax planning cannot be so large that the alternative is to cut pensions in half. Think about it. Pension plans are expecting to earn about 5% to 6% after tax (3% to 4% after inflation). If they earn 3% less than this every year (i.e. earn a 0% to 1% real return after taxes and fees), then they would need to double contribution rates or cut pensions in half. However, it is hard to see how the annual saving from using tax havens can be 3% of total assets under management (not 3% of amounts invested in foreign private equity). Even if they are saving this much, it seems to me that they should be able to earn a 2% or 3% real return by investing in public markets and real estate, like they used to do, and this would obviate the need to cut pensions in half.

Are Canada's "Big 8" public sector pension plans really saving $30 billion per annum (3% x $1 trillion) by using tax havens? I doubt it... but maybe I'm out of touch. In any event, those who make these claims should offer some support for them - not just throw big numbers around to frighten people. And if the "Big 8" are saving $30 billion a year and this covers half of the cost of their pensions, why is there no mention of any of this in their annual reports and financial statements? Why isn't the clever avoidance of foreign tax identified as one of the essential elements of the Canadian Pension Model, right beside good governance and high pay?
Jim Leech, OTPP's former CEO, clarified his comments to me:
That is the problem when a reporter says discussion is “for background only” and then quotes you – and then your words are taken literally and parsed by one of the best actuaries in Canada!

I was simply using hyperbole “off the record” to make a point that every dollar lost is a reduction in dollars available to pay pensions in reaction to reporter suggesting that pension plans should be morally obliged not to minimize taxes anywhere – point is the same if it only cost a few percent. Of course Malcolm is correct – it would not be nearly half.
So, this comment was taken "off the record and it doesn't represent the literal figure Jim had in mind.

I think the important point that is lost in all this is Canadian pensions have a fiduciary responsibility to minimize internal costs and maximize after-tax returns. Period. That's their job.

Second, I received and email from Suzanne Bishopric, the former CIO of the UN Pension Plan, who shared these insights:
Some of the so-called tax havens provide better custodial options than other jurisdictions, offering ample liquidity, transparent reporting, and legal predictability not always available elsewhere. Tax is not the only reason money market funds choose to be domiciled in the Cayman Islands or the Virgin Islands. Many tax-exempt funds find the convenience and liquidity ideal, without the need to avoid taxation.
I thank Suzanne for sharing her thoughts with my readers.

Lastly, CUPE Ontario is shocked and appalled that OMERS pension plan is investing in tax havens:
The revelation that the public sector pension plan, OMERS has been using tax havens to avoid their tax obligation has come as a shock to CUPE Ontario that represents the largest group of the pension plans membership. Tax avoidance is no way to fund a pension plan, says Fred Hahn, the union's president.

"No worker wants their retirement pension to be funded at the expense of community services or the wages of other workers," says Hahn. "As we age, our need for public services like health care actually go up. We still need our roads and bridges, we want good schools and child care for our grandkids. It is not acceptable that our pension plan is trying to avoid paying the very taxes that fund the services we need."

CUPE members make up 40 percent of the members in the OMERS pension plan, that is one of seven pension plans mentioned in the Paradise Papers.

"It's simply false to say that a pension plan has to practice unethical investment behaviour in order to make the necessary financial returns to meet pension needs of our retirees," says Hahn. "It is absolutely unacceptable that our pension plan is complicit in the corporate world view that it's ok not to pay taxes."

"The current corporate culture that believes making money is more important than what money is used for has left workers struggling and has eroded the quality of our public services," says Hahn. "We can and must invest in ways that benefit the people and the bottom line. As the largest member in the OMERS pension plan we believe strongly that the deferred wages of CUPE members lead the way in adhering to these standards."

On behalf of his members, Hahn intends to raise his concerns with the OMERS administration and will be demanding answers.

CUPE is Ontario's community union, with more than 260,000 members providing quality public services we all rely on, in every part of the province, every day. CUPE Ontario members are proud to work in social services, health care, municipalities, school boards, universities and airlines.
All I can say it's clear to me that CUPE Ontario doesn't get it, and they need to read over this comment carefully.