Obamaâ€™s Corporate Tax Reform: Implications for Canada
Canadian governments should revisit planned corporate tax cuts in light of President Obamaâ€™s proposals to moreÂ fully tax American firms operating outside the US.
The basic argument for lower corporate tax rates is that they will attract multinational firms to locate operations here as opposed to other jurisdictions. This argument assumes that profits are taxed only where they are generated. But if all of a corporationâ€™s profits are taxed by its home government regardless of where they are generated, the argument falls apart.
Throughout 2007 and 2008, I pointed out in letters to the editor, submissions to Parliament, and CCPA publications that the American, Japanese and British governments tax their corporations on a worldwide basis. As Canada cuts its federal-provincial corporate tax rate below the US rate of 35%, American companies operating here may have to pay the difference back to the US government rather than enjoying a lower total tax bill.
Finance Canadaâ€™s 2008 Tax Expenditures and Evaluations (released on Friday, January 2, 2009, for maximum exposure) addressed this point:
Under the “treasury transfer effect,” the revenue forgone by Canada could simply reduce the amount that the home country allows as a credit for foreign (i.e. Canadian) taxes, thereby increasing taxes payable in the home country. Such an outcome would result in a revenue loss for Canada without any favourable impact on investment. This is a potentially important concern with respect to the US, since it supplies about half of Canadaâ€™s inbound FDI [foreign direct investment].
After this surprisingly candid acknowledgement, Finance Canada went on to argue, “Given current institutional arrangements, however, the transfer of tax revenue to the US treasury should not now be considered a serious constraint on Canadaâ€™s choice of statutory rate.” But Obama just put forward different institutional arrangements.
Finance Canada had contended that, if American corporations reinvest their retained earnings in Canada rather than repatriating them to the US, they only pay Canadian corporate tax. Todayâ€™s proposal would discourage this practice “by requiring a company to defer any deductions – such as for interest expenses associated with untaxed overseas investment – until the company repatriates its earnings back home [to the US].”
Finance Canada had also contended, “US MNEs [multinational enterprises] are also able to use tax-planning techniques to indirectly repatriate income from low-tax jurisdictions without incurring additional US tax.” Today, Obama proposed to crack down on such techniques.
In summary, Obamaâ€™s announcement makes it more likely that American corporations will actually face the 35% US corporate tax rate on profits generated in Canada. The Government of Canada is now targeting a combined corporate tax rate of only 25% by 2012 (a 15% federal rate plus a 10% provincial rate).
If both plans are implemented, the US government would be able to collect 10% (i.e. 35% minus 25%) of taxable profits generated in Canada by American corporations. Canadaâ€™s federal and provincial governments shouldÂ keep this revenue by halting their corporate tax cuts.