How Trump’s tax reform will impact Canada

By Veronika Chang

Special to the Financial Independence Hub

On July 27, key Republicans from the U.S. House, Senate and White House released a joint statement on tax reform, echoing President Donald Trump’s tax plan announced earlier this year. In the statement, they repeated Trump’s commitment to make taxes “simpler, fairer, and lower.”

The GOP promises to protect American jobs, lower tax rates for all American businesses, and create a system that encourages American companies to bring back jobs and profits from overseas. The statement also had welcome news for many Canadian businesses since the border-adjustment tax is no longer on the table. It had been previously endorsed by Paul Ryan, Speaker of the House of Representatives.

Back in April, the White House revealed Trump’s tax plan promising significant tax cuts for corporations. His plan proposed to drastically cut the corporate tax from the top rate of 35% to 15%, which would be a welcome relief to American business. The initial plan with the border-adjustment tax would have unilaterally imposed U.S. tax on imports into the country, generating $1 trillion in revenue for the U.S. government. This border-adjustment tax would have replaced the revenue “lost” from the proposed tax cut.

75% of Canadian exports are to the U.S.

The U.S. is Canada’s largest trading partner, and exports to the U.S. represent about 75% of total Canadian exports. The border-adjustment tax would have been a heavy U.S. tax bill for many Canadian businesses, so its demise is a relief for any Canadian business with a U.S. presence. However, an America-first tax policy, along with the Trump administration’s tough stance during the initial NAFTA negotiation talks, will remain a concern for Canadian businesses, many of which rely on the American market.

The U.S. has one of the highest corporate income tax rates in the world. Slashing it to 15% would restore America’s competitiveness in the business world and give the U.S. a competitive edge over Canada, where the federal corporate tax rate is also 15%. In the past, tax-savvy American businesses have taken advantage of Canada’s lower corporate tax rate by moving operations north of the border; this is called an “inversion.”

In a typical ‘inversion’ deal, an American company buys and merges with a target company located in a lower tax jurisdiction where the newly merged company establishes its headquarters, even though key employees and operations remain in the U.S. Thus, an inversion results in only the profits moving to the lower tax jurisdiction. Such an inversion has been an attractive option for big American business.

US is reducing number of tax brackets and lowering top tax rate

For the individual, Trump’s plan may also result in a lower personal tax rate. Unlike Canada — which introduced a new income-tax bracket last year and raised the top tax rate from 29% to 33% — the U.S. would be reducing its number of tax brackets and lowering its top tax rate.

Trump has proposed to reduce the current seven tax brackets to only three: at 10%, 25% and 35%. The proposed top rate of 35% would be down from the current top rate of 39.6%. Details about the income threshold for these three brackets are lacking, but if Trump stays true to his promise of lowering taxes for all Americans, then most Americans will likely fall below the current top federal tax rate for Canada, which is 33%.

Also, if the difference between U.S. and Canadian tax levels is significant, Canada might experience another brain drain with qualified professionals moving south of the border in order to keep more after-tax earnings.

Repeal of estate tax

In addition to the downward movement in the U.S. tax rates, Trump’s plan calls for a repeal of the estate tax. U.S. citizens and residents are currently subject to U.S. estate tax of 40% if the person’s assets upon death are over the exemption amount. In 2017, that exemption amount is $5.49 million. For a wealthy individual, U.S. estate tax could be significant. This could explain why a record number of people renounced U.S citizenship in 2016, despite a five-fold increase in the government fee for doing so.

A lower U.S. income tax along with the repeal of the U.S. estate tax would mean that Americans can accumulate and pass on more wealth to the next generation. Many wealthy Canadians hesitate becoming U.S. residents for fear of being hit with the estate tax. But if the U.S. estate tax is no longer on the table, Canada might also experience more snowbirds making their permanent home south of the border.

Many pundits in the tax and business community wonder if the U.S. tax cuts are feasible without a border-adjustment plan to replenish the U.S. treasury. The border-adjustment tax, although never popular, was the Republican solution to raising revenue in order to offset corporate tax cuts and keep the budget deficit in check. So far, no one has proffered a new plan for how the U.S. government would pay for the proposed tax cuts. Paul Ryan prefers a corporate tax rate of 20% – not 15% as proposed by Trump –  although some wonder how that can be done in a fiscally responsible way.

But all this is only speculation until an actual change to the U.S. tax code occurs. The joint statement did say that the GOP expects the legislation to move through the committees this fall, followed by consideration in the House and Senate. But it’s anyone’s guess how long that may take.

Veronika Chang is a lawyer with Morris Kepes Winters (www.mkwtaxlaw.com) LLP in Toronto. She is a tax specialist with extensive experience working in the United States.