Proposed U.S. tax reform: clarifying the options

OTTAWA – Businesses in the United States and Canada are keeping a sharp eye on proposed U.S. tax reform plans originating from the White House and from Congress that could seriously impact their operations as well as their competitiveness. In yesterday's article, "Proposed U.S. tax reform could have major impact on Canada," we looked at the current state of taxation in the U.S. and the potential for a radical cut to 15 per cent.

Most analysts believe that would be unlikely. But if the U.S. corporate rate drops to 20 per cent that will still be a significant reduction. “If you’re at a 20 per cent rate, then you layer on state taxes — that probably puts you pretty close to what the Canadian/Ontario rate is. So it would end up almost being a push between the countries,” says Dennis Metzler, a Toronto-based U.S. tax partner with Deloitte Canada in Toronto. 

But the rate reduction will still be welcomed by U.S.-based businesses and Canadian or international companies wishing to do business in the U.S. 

“It would take some of the heat off companies that today employ elaborate planning to avoid having profits taxed in the U.S., since the higher U.S. rates drive up the overall effective tax rate on an organization’s earnings. They may not be so focused on trying to minimize U.S. taxation,” adds Metzler.  

The 20 per cent Congressional plan also calls for a border adjustment tax, under which U.S. companies would no longer get a deduction for imports, but would not be taxed on exports. 

“I think the consensus at this point in time is that it would be a huge battle to try and push the border adjustment tax through because there are so many groups lobbying against it,” notes Metzler. “Of course, that would include U.S. businesses that rely heavily on imports. For example, the apparel industry naturally has a very strong lobby against the enactment of a border adjustment tax,” he elaborates. 

A third proposal, put forward by Dave Camp, a former Congressman and Chairman of the House Ways and Means Committee, back in 2014, might also be in play. That included a proposed 25 per cent U.S. corporate tax rate. 

“It’s far less aggressive in terms of tax rate reduction than the other plans,” Metzler says. 

Bringing home the profits

The Trump Administration proposal also contains major changes in other areas, including an opportunity for businesses to repatriate profits that have been earned by multinational corporations overseas, which the White House estimates to be worth $2.6 trillion, through a one-time tax. 

“The way it works right now under U.S. rules [is] if a U.S. company has foreign operations, say a foreign subsidiary, the earnings and profits that are retained within that foreign subsidiary are not taxable in the U.S. until such time as the money is repatriated. But when the money is repatriated it’s effectively straight dividend income to the parent company, and it’s going to be taxed at the corporate tax rates. So if your net income’s in excess of $18 million…we’re talking a 35 per cent tax rate,” says Jason Kingston, a principal with the accounting firm DSK LLP in Kitchener. 

Currently, with the U.S. tax rate being so high, companies aren’t willing to bring earnings and profits that ultimately belong to U.S. parent companies back to the U.S. to redeploy globally. They want to redeploy it from the foreign jurisdiction to avoid having to pay the 35 per cent U.S. tax, he adds. 

“What was proposed is that this repatriation would be a 10 per cent tax rate. I think the hope is that [with] a 10 per cent tax rate … they would want to bring it back into the U.S. system to either pay dividends or to fund share buybacks or reinvest it in U.S. business. But at the same time, the U.S. government would get the 10 per cent cut of $2.6 trillion, which would help fund the lower overall tax rate,” Kingston elaborates. 

Territorial Tax

Another key tax reform proposal from the Republican blueprint and the Camp bill is to switch the U.S. from taxing corporations on worldwide income, whereby corporations are ultimately taxed regardless of where profits are earned, to a territorial tax system, as almost all other nations have, and which either fully or partially exempts from further U.S. taxation repatriated profits. 

This, in tandem with the repatriation provision, will have a very positive impact from a U.S. perspective, in terms of increasing capital investment in the U.S., predicts Russ Crawford, a Vancouver-based partner with KPMG Canada, who is in charge of that firm’s U.S. corporate tax practice in Canada. 

“It would really be just a groundbreaking change in the international system that we’ve all grown up with [in] advising U.S. companies,” says Metzler, who believes this measure would make the U.S. taxation system more competitive. 

This would also remove a significant burden from U.S. expats, including those living in Canada, who would no longer be required to keep up with fairly substantial U.S. tax filing requirements each year. Depending on where they’re living, they could be out from under U.S. tax liability, says Kingston. 

Tomorrow: U.S. tax reform may lower individual income tax rates. Jeff Buckstein, CPA, CGA, is an Ottawa-based business journalist.