Uber in Canada: Cutting corners on taxes and benefits

Uber pays no Corporate Income Tax in Canada and it avoids paying for all forms of employee benefits by declaring its drivers “independent contractors”. The truth is that Uber is not a benign intermediary between drivers and passengers but rather a $50 billion corporate behemoth designed by an army of lawyers to exploit regulatory grey areas for the expressed purpose of undercutting fares charged by its competitors.

This is the third installment of a four part series on Uber’s entry into Canada.

To summarize Parts 1 & 2: at the heart of Uber’s global business strategy is a political strategy. Because Uber has difficulty competing with established taxi companies under existing taxi industry rules, it needs to pressure Canadian licensing authorities into creating a separate set of taxi rules for it to operate under. Put bluntly: without its own set of rules that reduce its costs, Uber can’t afford to undercut the fares of existing taxi brokers – by far its most important competitive advantage.

There are four deal-breakers for Uber in any new set of licencing rules that it pries from governments through its ferocious lobbying: 1) the new rules must allow UberX to charge “surge pricing” with no maximum cap (think New Year’s Eve, an 8.9 times multiplier, and a $1,115 charge for a 60-minute ride in Montreal) while its competitors must continue to charge fixed-rate fares; 2) the new rules must exempt Uber from the commercial insurance coverage that is mandatory for licensed taxis so Uber drivers can carry a new, less comprehensive kind of “hybrid” insurance policy that is cheaper than commercial coverage; 3) Uber must be exempted from the existing licensing fees that govern both cab owners and drivers – and be given its own licensing fee regime with much lower fees; and 4) the background safety check rules for Uber drivers should not be so onerous as to scare off potential Uber drivers. For Uber this usually means that it objects to rules requiring that driver safety checks be done through local police departments.

Because getting new rules that lower its costs is so crucial to Uber’s business strategy, when Uber doesn’t get the above provisions in a new set of rules from taxi regulators, it will either leave the market (e.g. Calgary) or simply operate illegally outside the existing rules (e.g. Toronto and many other Canadian cities). For example, even though Calgary gave Uber much of what it wanted in a new set of rules passed by Calgary City Council in late February, Uber still pulled out of the Calgary market because the specifics of the new licensing fee and driver background check rules weren’t to its liking.

There are two other major areas where Uber plays by different rules that give it an advantage over its competitors: 1) its (apparently legal) international tax avoidance strategy; and 2) its (legally contested) claim that Uber drivers are independent contractors as opposed to employees. These issues, of course, are not regulated within municipal (or provincial) taxi licensing regimes but are nevertheless central to Uber’s Canadian (indeed global) growth strategy.

The rest of this post deals with Uber’s global tax avoidance and labour strategies.

Uber’s global tax avoidance strategy

Uber pays no Corporate Income Tax in Canada nor will it ever pay Corporate Income Tax as long as its present tax structure stays in place. The tax scheme Uber uses to facilitate this tax dodge is called Double Dutch and the Canadian version is virtually identical to the schemes in place in all territories where Uber operates. Nor is it very different from the tax structures put in place by tech firms such as Google, Apple and Facebook.

Here’s how it works.

Let’s say an Uber user in Toronto uses his smartphone to summon an UberX driver. At the end of the ride the details are recorded, and the rider walks away. No cash changes hands; it’s all billed through the rider’s credit card automatically. There’s no tipping and no fumbling with wallets/purses for cash.

Let’s also say, for argument’s sake, it’s a $50 ride. The fare is credited and sent electronically across national borders into the account of a company in Holland called Uber B.V. This company collects the fare and then, through another Dutch subsidiary (Raiser Operations B.V.), sends, in this case, $40 to the Toronto driver’s account. The remaining $10 enters a labyrinth of Dutch offshore entities.

The secret to the tax strategy is twofold. One, there is no recorded income for Uber in Canada. The Canadian driver, hopefully, pays provincial and federal personal income tax and HST on his Uber earnings, but Uber is invisible to the Canada Revenue Agency in this transaction – therefore no Canadian corporate tax.

Second, Uber B.V. is not Uber headquarters (that’s in San Francisco). Nor is Uber B.V. the international arm of Uber, set up to manage its operations. That’s Uber International C.V., another Bermuda-registered Dutch subsidiary. Basically, Uber B.V. keeps a small proportion of the Toronto fare to cover its expenses, and then transfers the remainder to Uber International C.V. through an “intangible property licence agreement.” Crucially, under Dutch law this royalty payment is not taxable.

This strategy is called Double Dutch because it uses two companies resident in the Netherlands connected by a licence agreement. The approach creates a mechanism for transferring revenue from tax-paying sources anywhere in the world to offshore entities tax-free.

Uber has 10 subsidiaries in the Netherlands, all of which are housed in the same building in Amsterdam. Only one of the companies, Uber B.V., has real employees. The rest are holding companies or shells.

Uber’s Double Dutch royalty income is not taxed in Canada, in Holland or in the United States (the home of Uber and most of its employees) – nor anywhere else for that matter. This income exists in a “grey zone” of international tax avoidance that’s growing by the day.

Tax strategies such as the ones that Uber (and Google, Facebook and Apple) use are enhanced by the very nature of their businesses—the fact that so much of the value of companies like Uber is in their intellectual property. It’s simply a lot easier to move your company’s intellectual property and the profits it generates to a tax-friendly offshore destination like the Netherlands than it is to relocate your manufacturing operations with its plants and heavy machinery.

The bigger problem with Uber – like many global corporations today – is that it avoids paying federal and provincial corporate taxes while displacing traditional businesses (such as taxis) that do. Corporate tax avoidance of this sort is exploding, and it’s burning a big hole in Canadian government treasuries.

For example, the federal government’s revenues have increasingly shifted towards personal income tax (PIT) paid by you and me.  For the first time ever, personal income taxes provided more than 50% of Ottawa’s revenues in 2014/15 – and are forecasted to keep rising. That’s up from a 30% share fifty years ago and even lower shares before then.

On the other hand, despite record profits, corporations provide just 13.6% of the federal government’s revenues in corporate income taxes.  That’s a third less than the over 20% share they provided during the boom years from 1946 to 1970.

Uber drivers: employees or independent contractors?

On June 17, 2015, the California Labor Commission ruled that Uber driver Barbara Ann Berwick was an “employee” of Uber – not an “independent contractor” as Uber claimed.

In a similar case, a California judge has set a trial date for a class action lawsuit challenging the way Uber classifies its drivers as independent contractors. Judge Edward J. Chen ruled that the trial will start June 20th, 2016, and will last five weeks. The case, O’Connor v. Uber, gained some steam in March 2015 when Chen denied Uber’s motion for summary motion and in September when he certified the case as a class action.

Of the two, the class action lawsuit is expected to have more wide-reaching effects but together the cases have potentially huge implications for Uber in Canada as well as the U.S.

Here’s why.

Uber’s current business model skirts around the official definition of an “employer.” They consequently avoid the regulations (and payroll costs) that come with that status. Uber contends that its drivers are “independent contractors”— self-employed individuals hired for specific services — and not employees. Uber sees itself as a mere intermediary, connecting service providers and users, in this case drivers and riders.

To be fair, Uber makes significant claims to support this argument. Drivers own their cars, are responsible for their own working hours, and are free to provide work for other contractors, such as taxi or limousine services. The criteria change somewhat if you’re looking at the Canada Revenue Agency or provincial labour law, such as Ontario’s, but generally these are all essential features of an independent contractor relationship.

But this is a limited perspective and both American and Canadian common law cite other important factors that must be taken into consideration when making the determination. For example, it is sometimes argued (and was argued in the California Labour Commission ruling) that the primary legal distinction between an independent contractor and employee is one of control, whether control is only the result of a job or the means and methods: when you work, how you work, where you work. The truth of the matter is that Uber sets rates for its drivers, strictly monitors their performance, and gives detailed requirements such as what kind of car they drive, what route they must take, and how clean their car should be. This is arguably a form of control on how a job is done, not only if a job is done. Additionally, Uber has the right to discharge any driver and perhaps most importantly, determines  how the passengers must pay the driver (through its app) and the credit worthiness of the passenger (must have a credit card) .

It is also important to note that the independent contractor classification is worth billions to Uber. Ultimately, the difference between an independent contractor and an employee is far more than just semantics. It is a difference of employee benefits, including health insurance, disability, and retirement. It is a difference of eligibility for employee protections, such as minimum wage, overtime, employment insurance and CPP. And it is a difference of payroll taxes; independent contractors are responsible for their entire contribution to payroll taxes.

These combined expenses would increase Uber payroll costs between 20 and 30 percent if its “independent contractors” were employees. In other words, Uber’s primary business advantage over existing taxis – its generally lower fares – is in part made possible by the “independent contractor” status of its drivers.

So what’s at stake here isn’t just an abstract legal debate; we’re talking about decisions that  could potentially affect the lives of tens of thousands of Canadian employees in the broader so-called sharing economy and many times that globally.

In fact, the real significance of the California class-action case can only be understood in the context of Uber’s position as the poster child of the “sharing economy”. If the independent contractor classification stands in the California Uber class action case, it could set a precedent for the so-called sharing economy as a whole. If Uber is allowed to call its drivers “independent contractors”, its counterparts in retail, hospitality, transportation, and communication could follow in its wake. A growing percentage of the labor force will be categorized as independent contractors with the dearth of benefits that accompany that status.

Conclusion

While Uber likes to advertise itself as a technology company that provides a software platform to connect drivers with passengers needing a ride, what it really is is a $50 billion global corporate behemoth carefully designed by an army of lawyers to exploit every possible regulatory grey area in order to reduce its costs and undercut the fares charged by its competitors – the traditional taxi industry.

Is the public interest served by a taxi industry that charges fixed fares so that passengers (many of them elderly and without access to a car) pay a predictable amount for a given distance? Absolutely, but fixed fares don’t fit with Uber’s business model so it insists that licensing governments rewrite their taxi rules to create a special category of taxi service that allows Uber to charge fares up to ten times higher than normal fares in periods of high demand. Uber euphemistically calls this “surge-pricing”.

Is the public interest served by background checks on drivers done through local police departments as is generally the case for drivers in the taxi industry? For sure, but background checks done by local police departments don’t fit into Uber’s business model so it insists that regulators design special rules that allow its drivers to avoid a police background check when vetting Uber drivers.

Is the public interest served by large, multi-national corporations paying their fair share of corporate taxes? Almost certainly, but Uber routes its local income electronically across borders to a labyrinth of Dutch based off-shore entities so that not only is there no corporate income tax paid on Canadian revenue but there is also little or no corporate income tax paid in the Netherlands or the U.S., where Uber is headquartered.

Is the public interest served by all workers being covered by employment rules that provide for a minimum set of protections and benefits such as minimum wage and overtime? Of course, but Uber wants to keep its costs down so its business model can’t accommodate traditional employee protections. It therefore insists that its drivers are “independent contractors” – even though Uber exerts enormous control over their work lives by setting rates for its drivers, strictly monitoring their performance, giving detailed requirements such as what kind of car they can drive, and dis-charging a driver from Uber service pretty much at will.

What should be done in response to the Uber invasion to reassert the public interest? Part 4 will look at a range of Canadian public policy options to deal with the Uber challenge and the larger “sharing economy”.