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By Dan Lundenberg, BDO Canada LLP
Special to the Financial Independence Hub
For Canadian businesses that have been wanting to explore their prospects south of the border, the United States’ recent tax reforms could provide that impetus to finally make that happen.
In mid-December, the U.S. Congress agreed to aggressively cut its corporate tax rates from a maximum of 35 per cent to 21 per cent. In addition, the U.S/ reduced its top personal tax rate to 37 per cent and this can be reduced for certain owners of pass-through entities to 29.6 per cent. These changes open the door for Canadian business owners to invest or set up a shop in the U.S. without fear of higher taxation.
The U.S. tax reform comes on the heels of the Trudeau government’s move to roll out proposed tax changes that would make it more difficult for Canadian businesses to use private corporations to be tax-efficient. After receiving backlash from small business and industry groups, Finance Minister Bill Morneau in October unveiled a gentler tax plan geared to target mainly high-income Canadians.
But still, the revised tax changes would constrain the ability of businesses to implement tax efficient structures through income “sprinkling” with family members. Using small business corporations as a vehicle for making passive investments would also be more cumbersome under proposed changes.
While Canada is making it harder for private corporations to reduce taxes on certain income, the U.S. just widely opened its door to slash taxes for private businesses. In Ontario alone, assuming profits are paid to its shareholders, an integrated top rate of 54 per cent would apply. In the U.S., the tax hit in a pass-through vehicle would only be roughly in the mid-30s, depending on the state where the business is conducted.
Winners and Losers
So, what does this new U.S. tax environment mean for Canada?
Just recently, a business acquaintance just asked me how he can move and set up a business in the U.S. now that the tax rates there are much more competitive.
Canadians business owners thinking of moving to the U.S. will have to consider immigration, health insurance, manpower cost, and other relevant issues that may have a significant impact on their ability to move to the U.S. But taxes — one of the largest line items on the income statement — often drives business decisions, particularly for mobile entrepreneurs who can virtually operate anywhere.
This could particularly apply to capital-intensive industries that will be the biggest winners with the U.S.’s new tax measures. US corporations may now be able to write off new capital investments without having to amortize them over five, ten or 15 years, which will enable them to recoup their investments immediately.
With Canada’s less competitive tax environment, the country could lose some businesses that are looking for a bigger and more lucrative market with more tax incentives.
What else can Canada do?
To prevent this potential outflow of Canadian entrepreneurs, the Canadian government will need to ramp up tax incentives in other areas to offset higher tax charges on corporate income.
For example, it could look at its tax incentives for research and development, which are currently stronger than what the U.S. offers. Canada can also further reduce the impact of the private corporation changes.
Tax incentives may not be the only way to help keep and sustain small businesses. But it is a crucial component that can’t be ignored to help nurture and sustain entrepreneurs in Canada.
Dan Lundenberg is Partner and Leader, U.S. Corporate Tax Services, for BDO Canada LLP.
