Canada: An "America First" Tax Reform: Potential Impact On Canadian Companies

A nine-page framework (the Unified Framework for Fixing Our Broken Tax Code [PDF]) was released on Wednesday, September 27, by the "Big Six" group of Republican Congressional leaders and the White House that outlines key areas of U.S. tax reform. After months of dealing primarily in abstract concepts, the Big Six has finally brought some structure to the tax reform discussion. However, much of the hard work and line-drawing has been punted to Congressional tax writing committees. In addition, the framework will no doubt initiate "open season" for tax lobbying and other forms of politicking as various interest groups try to preserve their interests. As a result, it is difficult to know whether this unified proposal in its current form will withstand the political assault to follow.

Given the interconnectedness of the Canadian and the U.S. economies, the proposals in this framework would have a significant and real impact on Canadian businesses. Canadian businesses with U.S. operations may need to revisit their cross-border operations and planning in light of potential changes in U.S. tax rules. Forward-looking Canadian businesses may also want to consider the potential impact on their businesses if U.S. tax reform were to result in "increased competitiveness" of U.S. companies, both inside and outside the United States.

Key areas of interest to Canadian businesses with U.S. ties include:

  • Corporate tax rate reduction: The U.S. corporate tax rate would be reduced to 20% and AMT eliminated. In recent history, there have been growing incentives for Canadian companies to tilt profits from U.S. operations to Canadian operations given the lower Canadian corporate tax rate (25%). Canadian businesses with U.S. operations would need to re-examine their cross-border intercompany arrangements in light of any reduction in the U.S. corporate tax rate. The collateral effects of rate alignment may well be far reaching and challenge many cross-border tax planning "norms." One sleeper issue that may still emerge as a prominent feature of tax reform is the implementation of corporate "integration." Senator Hatch (Chair of the Senate Committee on Finance) has championed this idea which may allow U.S. corporations to claim a deduction for dividends paid and, in lieu of corporate level tax, there would be a 35% withholding tax on such distributions.  It is not clear whether this withholding tax would be reduced under U.S. tax treaties.
  • Capital expensing: As a prior statement released in July had foreshadowed, the framework provides for "unprecedented capital expensing," allowing businesses to immediately deduct the cost of new investments in "depreciable assets other than structures made after September 27, 2017," for at least five years.
  • Limitations on interest deductions: Without further details, the framework provides that the deduction for net interest expense incurred by corporations will be "partially limited."  There is a wide range of policy outcomes here and the resolution of what "partially limited" means will be closely watched by Canadian companies. For example, the limitation may be merely a necessary corollary of immediate capital expensing, discussed above (i.e., in order to avoid a double deduction with respect to borrowing incurred to acquire capital property whose cost is immediately expensed). On the other hand, this limitation may also be more aggressive tightening aimed at eliminating the tax preference for debt as compared to equity.   
  • Territorial system: The framework exempts from taxation dividends received by a U.S. parent from a foreign subsidiary in which it owns at least a 10% interest (i.e., a participation exemption), and provides a one-time two-tier tax on accumulated foreign earnings (with a lower rate for illiquid assets) to be imposed over the course of "several years." It leaves the specific rates to be determined by the Congressional committees.
  • Base erosion prevention: The framework signals a strong commitment to anti-base erosion measures by directing the committees to incorporate rules to "level the playing field between U.S.-headquartered parent companies and foreign-headquartered parent companies." While the precise form of these measures is not addressed, one can reasonably expect enhanced earnings stripping protections (perhaps similar to those endorsed by Action 4 from the BEPS project) and other measures designed to remove the incentives for inversions. In addition, the framework calls for a global minimum tax to be imposed on foreign profits of U.S. multinational corporations at a "reduced rate" in order to prevent U.S. companies from "shifting profits to tax havens."  There is significant uncertainty (if not confusion) about how this minimum tax concept would work, but it appears aimed at minimizing any residual incentives that may remain in a territorial system for U.S. multinationals to migrate income to tax havens.

As noted above, the framework leaves most of the details unanswered, including how the tax cuts will be funded. As a result, the framework is best viewed as a starting point and it remains to be seen how much of it holds up under intense political pressure and deal making. That said, Congressional leaders and the White House have staked out some clear positions and indicated that the goal among lawmakers remains that U.S. tax reform be passed by the end of 2017. This means the last quarter of 2017 will be particularly intense. We will keep you informed about key updates as the drafting process continues.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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