On January 20, the United States will likely swear in a new president, Democrat Joe Biden. This year’s election was extremely close so there’s potential for recounts and legal challenges in some of the states where the race was especially tight. As it stands currently, Biden has been declared President Elect but President Trump has not yet conceded the race.
New president = New tax policy?
With a new US administration potentially at the helm, Canada—which is traditionally dependent on the US market—is hoping for a strong US economy, but also for policies that don’t adversely impact Canada’s access to this competitive marketplace.
With a Biden win, Canadian businesses should prepare for the possibility of tax changes that will impact their activities south of the border, as we outlined in our pre-election coverage. However, tax policy change is not a certainty as the Democrats will likely not control the Senate even though they may have a majority in the House as well as control of the oval office. In this article, we’ll discuss changes that may take place and what Canadian businesses need to be aware of. Specifically, we’ll review:
- Canadian tax and Canada’s competitive advantage
- Global mobility and immigration
- International tax
- Transfer pricing policy
- US state taxation
Canadian tax and Canada’s competitive advantage
Although there are some elements of Biden’s proposed tax changes that will arguably improve Canada’s competitive tax advantage in some ways, overall these changes are likely to be disadvantageous to Canadian companies with US operations and Canadian foreign investment.
Prior to the 2018 US tax reform, Canada’s combined corporate tax rate was significantly lower than the United States’ combined rate. Tax reform reduced the US federal corporate tax rate to 21 percent, resulting in a combined corporate tax rate slightly lower than Canada’s. An increase in the corporate rate to 28 percent under the Democrats would improve Canada’s tax advantage for foreign investment compared to the United States, as the US corporate tax rate would now exceed Canada’s. Likewise, the elimination of bonus depreciation provisions permitting full depreciation of US-based capital assets in the year of acquisition would also make the US less attractive to foreign investors considering expansion into either the US or Canada. That said, such changes would ultimately result in Canadian businesses with US operations paying more US taxes overall.
Further, if the Democrats use increased revenues from their tax proposals to fund significant infrastructure projects, launch green initiatives to reduce carbon emissions and reduce debt, it could attract foreign investment away from Canada. This is because several of the Democrats’ proposed measures are aimed at fostering growth by domesticating US businesses, particularly manufacturing activities. For instance, one of the proposals would provide a 10 percent tax credit to companies making an investment in domestic manufacturing (e.g., by revitalizing closed factoring or increasing manufacturing wages). This could incentivize companies to move their manufacturing activities to the United States rather than Canada—and many Canadian businesses could choose to expand their manufacturing operations into the United States as well.
Global mobility and immigration
A Biden presidency could also make Canada less competitive from a talent perspective because, up until now, Canada has benefitted tremendously from US immigration restrictions. This could all change if a Democratic administration rescinds the current “travel ban” on largely Muslim-majority countries and loosens access to the H-1B visa program for skilled foreign workers—as the United States would once again become attractive to talent that would otherwise have considered immigrating to Canada.
A movement of manufacturing into the United States under President Biden’s manufacturing credits could also result in many Canadian businesses sending employees south of the border as they expand their US operations.
Additionally, the Democrats hope to enact a number of tax policies that would raise taxes on individuals in the $400,000-plus income range. This includes
- hiking the top individual income tax rate from 37 percent to 39.6 percent for taxable incomes above $400,000;
- taxing long-term capital gains and qualified dividends as ordinary income (resulting in a 39.6 percent tax rate on income above $1 million); and
- applying the Social Security tax to all employment income over $400,000 (which could result in increased tax costs for employers choosing to relocate employees to the United States).
President Biden’s proposed increased corporate tax rate may impact how Canadians fund their US subsidiary operations and acquisitions—and potentially make debt financing more preferable.
This is because, from a US tax perspective, debt financing reduces US taxable income (and consequently tax payable) while facilitating a tax efficient repatriation of after-tax profits to Canada.
Although more sophisticated structuring may be available to reduce taxation of debt financing in Canada, depending on Canadian tax attributes, straight debt financing may result in greater amounts of Canadian tax paid compared to the reduced US tax liability (particularly for Canadian controlled private corporation).
An increased corporate tax rate eliminates the leakage of passive income earned by Canadian-controlled US subsidiaries—a trend that has occurred since the 2018 US tax reform. This income is taxable in Canada on a current basis to the extent that it is not subject to US tax at a 25 percent rate. This may simplify the reporting of a Canadian corporation’s foreign investments for tax purposes.
A corporate tax rate increase from 21 percent to 28 percent also generally removes the necessity of locating strategic decision-making authority in the United States for purposes of accessing a full dividend deduction on the distribution of after-tax profits (other than in the case where financing structures have been implemented).
Transfer pricing policy
For Canadian companies, the 2018 US tax reform changed everything from a transfer pricing perspective. On the one hand, lower US federal corporate tax rates encouraged Canadian businesses to create a corporate presence or expand their existing US operations to increase US sales and profits. The introduction of the FDII deduction in the United States, meanwhile, encouraged Canadian businesses to minimize the profit of their Canadian entity and shift income into the United States.
President Biden’s election win puts the status quo at risk. As noted above, the Democrats’ tax platform includes proposals to increase the federal corporate income tax rate from 21 percent to 28 percent. In addition, there is a proposal to introduce an alternative minimum tax based on book income for companies that exceed $100 million in net income but do not pay any federal income tax.
The Democrats also propose to double the GILTI (Global Intangible Low-Taxed Income) tax rate from 10.5 percent to 21 percent and assess a minimum tax on a country-by-country basis. Additionally, the party has advocated for a “Made in America” tax credit to create more US manufacturing jobs (although, it should be noted, other industries are currently not considered as part of this tax credit).
Should the Democrats succeed in making these changes, businesses will be encouraged to change their transfer pricing structures to once again shift profits out of the United States and into Canada. There may also be a greater likelihood of inversion of companies, especially after taking into account any GILTI tax considerations.
During the election, the Democrats’ tax platform did not have a clear agenda on tariffs. Although President Biden has historically been pro free trade, economic factors such as increased unemployment rates, growing deficits and pressure to encourage “Made in America” behaviours may create significant uncertainty and adversely affect Canadian exports.
The Democrats’ Buy America proposal—in addition to their desire to link trade policy to climate objectives—will advance US trade interests but create a disadvantage for Canadians. A Biden administration intends to rejoin the Paris Accord and levy sanctions on carbon-intensive goods imported from countries that are not meeting emission targets. As Canada is not projected to meet its required targets under the Paris Accord, Canadian exports may become subject to such sanctions.
Nearly every state that imposes a corporate income tax conforms to the federal tax laws in some manner. These states are split with respect to whether their conformity is rolling or static. States that have rolling conformity provisions adhere to the current version of the federal rules and must pass legislation to decouple from the reform provisions. In contrast, states that have static conformity dates adhere to the federal code in effect as of a particular date in time. To conform to any amendments made on the federal level, the state legislature in these states must pass legislation incorporating those changes into the state tax code.
This inconsistency adds to the already difficult task of identifying how each state will respond to tax law changes. It is also worth noting that it can take some time for the states to determine the impact federal tax changes will have on their state. Many states are still in the process of providing guidance on how the 2017 Tax Cuts and Jobs Act, signed on December 22, 2017, impacts state income taxes. Lastly, states have the power to decouple from a greater number of federal laws that have revenue impacts on them post-COVID-19, in light of their own revenue problems.
Food for thought
The results of this election will definitely give Canadian businesses lots to consider when it comes to international business strategy. In the coming months, we will be watching for legislative developments and keep you apprised of pending legislation and how it will impact Canadian business—so stay tuned. In the meantime, if you have any questions—or would like clarification on some of the points outlined in this article—don’t hesitate to reach out to one of our Grant Thornton advisors.
For more related Insights, please visit our 2020 US election hub.