I recently questioned whether Tim Hortons’ reorganization as a Canadian corporation would bring any additional jobs or tax revenue to Canada. Aaron Wherry since did something that journalists covering the Prime Minister’s photo-op on this issue should have done: he asked the company directly. Its response is now available on the Macleans blog.
Of course, Tim Hortons hopes to expand its operations and thereby enlarge its profits. If successful, such growth would generate more jobs and tax revenue in Canada. However, the company does not claim that its expansion plans are motivated by lower Canadian corporate tax rates.
Indeed, its business operations are a classic case of insensitivity to corporate taxes. For example, a manufacturer can arguably relocate its production facilities in pursuit of lower tax rates and then ship its output to market anywhere. By contrast, Tim Hortons must situate its stores (and most of the supply chain supporting them) in the markets that it aspires to serve.
In response to corporate taxes, the company can alter its legal form but not many of its actual operations. As it readily acknowledges, “Operationally, the reorganization will not result in any immediate new jobs.”
The more interesting question is whether the changed legal form will cause more profits to be reported and taxed in Canada. The Canadian government generally only taxes profits generated in Canada and exempts profits generated by the foreign affiliates of Canadian corporations. Therefore, I saw no reason to expect that Tim Hortons would pay more Canadian tax as a Canadian corporation.
The company’s answer is slightly different: “Yes, initially, Tim Hortons will pay more taxes to the Canadian government. Over the next few years, as the effective corporate tax rate decreases, the amount of taxes we pay will then decrease.”
The fundamental point is that, after an initial blip in tax payments, falling corporate tax rates will more than offset both actual profit growth and incentives to shift reported profits to Canada. In Tim Hortons’ own estimation, its Canadian tax payments will decrease. This statement is notable, given that corporations generally have an interest in toeing the line that lower corporate tax rates will increase corporate tax revenues.
. . . assuming we complete the reorganization in 2009, we would incur certain tax charges, primarily non-cash, that would result in our expected effective tax rate for 2009 falling within the range of 37% to 39%, rather than our previously announced targeted tax rate range for 2009 of 32% to 34%.
Of course, this 5% increase is temporary. The reorganization will then reduce Tim Hortons’ effective tax rate from the original baseline by 4% in 2010, 6% in 2011 and 8% in 2012.
Unfortunately, these numbers (and others I have checked) do not distinguish between Canadian and American tax payments. However, the filing indicates:
. . . we expect that the reorganization will not result in any material Canadian federal income tax liability to any of THI USA, New THI or THI Mergeco (other than the discrete tax charges described above under “Summary Pro Forma Financial Information”).
That summary indicates:
Additional adjustments would be to decrease deferred income tax assets by approximately $24 million, decrease deferred income tax liabilities by approximately $9 million, increase current income taxes payable by approximately $6 million, and decrease retained earnings by approximately $21 million. These adjustments arise primarily in connection with the realizability or utilization of deferred tax assets related to certain U.S. tax attributes . . . Additionally, as a result of the reorganization, U.S. federal withholding taxes will increase in 2009 by approximately U.S. $12 million (approximately Cdn. $13 million), offset by a release of previously accrued Canadian withholding taxes of $11 million.
So, most of the tax blip reflects the loss of US tax credits that could otherwise have been used to defray future US taxes. One must conclude that only a minority of the one-time tax increase will flow to Canadian governments.
Canada will also lose the withholding taxes that would have been collected on dividend payments from Tim Hortons’ Canadian operations to the US-registered corporation. Therefore, any initial increase in Canadian tax revenue will be small and quickly eclipsed the subsequent, ongoing decrease in tax revenue.
A further question, which David Olive has already explored, is whether the reorganization was actually motivated by corporate tax cuts. Throughout the filing, Tim Hortons affirms its eagerness to take advantage of lower Canadian corporate tax rates.
However, the “Background and Reasons for the Merger” section provides several other compelling rationales. For example, “the reorganization will allow us to address certain adverse implications of the Fifth Protocol of the [Canada-US Tax] Treaty.”
Perhaps more importantly, Tim Hortons became an American corporation when it merged with Wendy’s. Even after separation, it was locked into a tax-sharing agreement with Wendy’s.
When that agreement recently expired, there was no longer a reason to keep Tim Hortons organized as a US corporation when some 90% of its revenue is generated in Canada. In particular, it did not make sense for the company’s entire business, which is overwhelmingly conducted in Canadian dollars, to be taxed and analyzed in US dollars.
Therefore, it seems highly probable that Tim Hortons would have reorganized as a Canadian corporation even had Canada simply kept its corporate tax rates at US levels. If so, the Canadian government might have received a similar temporary boost in tax revenue from this reorganization without the ongoing loss of future tax revenue.
Finally, I apologize to Susan Delacourt for reusing her post title, but as they say, imitation is the highest form of flattery.