Canadian competitiveness has been top of mind ever since the U.S. lowered its marginal corporate tax rate to 21% late last year. Federal Finance Minister Bill Morneau has repeatedly said that the government is exploring ways to respond to the U.S. tax cuts.
Morneau said he’s been on a listening tour, hearing from Canadian businesses and stakeholders about the best way to respond to the U.S. tax cuts.
At an October 3 event hosted by the Greater Vancouver Board of Trade, Morneau said competitiveness concerns he’s been hearing have less to do with rates and more to do with the ability for companies to deduct equipment expenses within the year that they are made.
“The issue I’ve heard from people is much more about the opportunity for Americans with investments to have accelerated depreciation.”
Morneau said Ottawa is considering ways to bridge the difference between the depreciation schedules in the two countries.
It’s not known what measures will be taken, but Morneau hinted that changes would be announced during the November 21 economic update.
While the finance minister has been touring the country, businesses have been making their voices heard. At the Empire Club of Canada in Toronto, CIBC (TSX:CM) president Victor Dodig said accelerated capital cost allowance is a key issue.
“That’s something we should really be thinking about in Canada to be able to attract that capital on the margin.”
Morneau appears to be listening.
While the specifics are not yet known, some media reports have suggested that a business’ ability to deduct assets, like equipment, is a likely target for change.
However, it’s not certain that this will be the action the government ultimately takes.
“I don’t even know if we have certainty that this is the tool that Ottawa’s going to use,” said Avery Shenfeld, managing director and chief economist at CIBC Capital Markets. “What we’ve heard the finance minister say is that they are studying ways of responding to the challenges posed by U.S. tax changes and other factors.”
If Canada chooses to go down this road, it would be a direct response to U.S. changes that allowed companies to deduct the full purchase price of equipment bought during the tax year, up to $1 million.
The fear is that companies will have more incentive to invest south of the border rather than in Canada because they can save roughly $210,000 on their tax bill.
Shenfeld said the change would be a targeted measure that would attract investment and reduce the business cost of expansion.
One of the benefits of a more targeted measure like accelerating the capital cost allowance is it would have less of an impact on tax revenue, particularly compared with simply lowering the corporate tax rate. Instead of giving businesses a deduction spread over multiple years, the deduction will be front-loaded, and companies could reap an immediate benefit for investing while not reducing tax revenue in the long run.
However, the move won’t necessarily help everyone.
Darren Millard, cross-border tax adviser and founder and CEO of Facet Advisors, is concerned that small businesses stand to gain less than bigger companies from an accelerated depreciation timetable.
Small businesses are taxed preferentially on their first $500,000 in earnings, with a 15% tax rate rather than 26.5%. If a business used a deduction to go below $500,000, it could lose some of the small-business tax advantage.
Prior to America’s federal tax changes, Canada had a more than 12.8% advantage in its average effective corporate tax rate over the U.S., after taking into account credits and deductions that reduce a corporation’s tax liability.
According to a March 2017 U.S. Congressional Budget Office (CBO) report, Canada had the third-lowest average corporate rate in the G20 at 16.2%, behind Germany and the U.K., based on information from 2012.
The U.S., on the other hand, had an average corporate tax rate of 29%, third highest in the G20. While the CBO did not have a comparable post-tax-cuts number, a study by the University of Pennsylvania’s Wharton School found that the average corporate tax rate in 2018 would be 9.2%, climbing to 17.3% by 2023. That same study calculated the 2017 U.S. average effective corporate tax rate to be 21.2%, almost eight percentage points lower than the CBO’s calculation of the rate before the cuts.
“It isn’t that we’re stunningly offline with other countries, and even on overall corporate taxes, it’s not that the U.S. is dramatically lower than Canada,” Shenfeld said.
“It’s just [that] we need all the help we can get to attract businesses to our side of the border given ... the fact that the U.S. is the bigger market.”
Not everyone thinks this is the best move Canada could make. While Millard likes the idea of accelerated capital cost allowance, his preferred strategy would be to cut both the personal and corporate rates.
On the other hand, Shenfeld said, accelerating the capital cost allowance not only is a cheaper way to increase competitiveness, but is also more targeted.
Rather than rewarding all businesses with lower taxes, the government, by focusing on deducting assets like equipment, would reward only businesses that make the decision to invest in Canada rather than the U.S.
Accelerating the capital cost allowance is also a more targeted measure than increasing the capital gains allowance. Currently, Canadians pay tax on only 50% of the profit made by selling assets, whether it be real estate or stock.
Kevin Milligan, professor of economics at the University of British Columbia’s Vancouver School of Economics, noted that the preferred tax treatment of capital gains rewards investments that were made in the past by lowering taxes paid at the time of sale.
Accelerating the capital cost deduction rewards new investments rather than those made in the past. •
