President-elect Donald Trump’s ascension to the highest office in the land was unexpected by most. Before his election on November 8, the consensus among U.S. tax practitioners was that the top marginal U.S. federal tax rates for individuals were poised to increase for high-wage earners and U.S. corporate tax reform, while newsworthy of late, would be nominal with a Democratic-controlled executive branch and U.S. Senate.
Little attention was paid to Trump’s tax plan, which he rolled out in September 2016. Everything changed on November 9, when the world woke up to news of an impending Trump presidency.
The following details of Trump’s tax plan would affect Canadian businesses that operate in the U.S.:
· U.S. federal corporate tax rates would be reduced from 35% to 15%;
· Pass-through entities could elect to be taxed at a flat rate of 15%;
· U.S. federal estate and gift taxes would be eliminated and replaced with a capital gains tax at death (similar to deemed dispositions in Canada at death); and
· Firms engaged in manufacturing activities in the U.S. could elect to expense capital investment or interest paid.
Canada’s competitive advantage
To put this pivot in perspective, currently the U.S. has one of the highest corporate tax rates in the world. The combined U.S. federal and state tax rate can easily exceed 40%. Canada has enjoyed a competitive advantage in this regard, with a combined federal and provincial corporate tax rate of approximately 26%. As a result, Canadian companies doing business in the U.S. have an incentive to allocate more of their profits to Canada.
In order to justify this allocation, Canadian companies will generally keep most management and capital investment in Canada. Losing this competitive advantage could encourage Canadian businesses to invest more of their capital and resources in the U.S. at the expense of their investments in Canada.
New opportunities for B.C. businesses
These changes should affect all Canadian business sectors with cross-border investments in the U.S. Canadian investors in U.S. real estate could be especially affected by the proposed changes. Much of the tax planning in this area has involved the use of structures that minimize exposure to U.S. federal estate tax but take advantage of lower preferential U.S. individual income tax rates for capital gains. Elimination of the U.S. federal estate tax and reduction of U.S. corporate tax rates to 15% create opportunities to revisit these structures.
Canadian businesses with manufacturing in the U.S. stand to benefit from Trump’s proposal to allow firms that manufacture in the U.S. to expense certain capital costs in the year incurred. Canadian lumber companies that have purchased U.S. sawmills and are engaged in manufacturing in the U.S. can benefit from these changes and may decide to invest more or expand in the U.S. rather than seek similar opportunities in Canada.
Staying competitive for skilled foreign workers
Not only does Trump’s tax plan address U.S. business tax reform, but it also lowers the top U.S. federal individual income tax rate from 39.6% to 33%. This would lower combined U.S. federal and state individual income tax rates to approximately 40%. Some commentators have suggested that Canada’s ability to attract and retain talented foreign skilled workers could be affected because of the comparably higher individual income tax rates in Canada – which can exceed 50% in some provinces.
There are always two sides to a story. Many potential immigrants to the U.S. may see the election of Trump as an affirmation of American nativism and hostility towards immigrants in light of rhetoric attributed to him during his campaign. In this regard, Canadian businesses stand to benefit because Canada may be viewed as a more attractive place to settle because it projects a more inclusive immigration posture.
Uncertainty for Trump’s tax plan looms
When Donald Trump takes the presidential oath of office in January, both the executive and legislative branches of government will be controlled by Republicans. However, Republicans will not have 60 seats in the Senate, which would have been enough to overcome a Democratic filibuster that could block Trump’s tax plan from getting an up or down vote. Nevertheless, there is a congressional mechanism, called budget reconciliation, that could be used to subvert a filibuster attempt.
I am of the opinion that Trump’s tax plan is a bold overture but one that will look quite different when finally enacted. Another issue is that without substantial offsetting spending cuts that would pay for the projected reduced federal revenue, Trump may be leaving his successor with a “yuuuge” deficit, so query how long such tax cuts will last. Only one thing is for certain: there is much uncertainty ahead.
For more information, contact Sidhartha Rao, JD, LL.M. (U.S. tax), MNP International Tax Services, at 604-637-1510 or [email protected].
