Canada Looks to Close C$1.24 Billion Tax Loophole for Banks

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Canada is closing a tax loophole used by financial institutions on derivatives contracts, saving the government as much as C$1.24 billion ($1 billion) over four years.

Under a proposal in the federal budget, banks will no longer be able to claim an income-tax deduction on dividends paid by Canadian companies under certain derivatives contracts. As part of these transactions, a bank typically buys shares in Canadian companies as a counter party to a derivative investment taken out by a pension fund or other institutional investor. These derivatives allow investors to make bets on equities or stock indexes without owning the actual shares.

While the pension fund is taking the risk of owning the shares, the banks are able to claim a deduction on dividends paid by these firms, according to these so-called dividend rental arrangements.

These “synthetic equity arrangements” have the “potential to significantly erode the Canadian tax base,” according to the budget document released Tuesday in Ottawa.

The proposed tax change represents one of the biggest tax measures included in the budget. The government expects to recoup C$365 million in tax deductions next fiscal year, for a total of C$1.24 billion over four years. Closing the loophole will more than offset the foregone taxes from the doubling of the annual limit on tax free-savings accounts over the next five years, budget figures show.

Canada’s financial industry will examine the proposal and use the government’s consultation period to weigh in, said Terry Campbell, president of the Canadian Bankers Association.

“The banking industry is one of the most highly taxed industries in Canada, paying nearly C$8 billion in taxes in 2013,” he said. “We will be looking closely at these measures and discussing them with our members.”

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