Obama’s Corporate Tax Reform: Implications for Canada

Canadian governments should revisit planned corporate tax cuts in light of President Obama’s proposals to more 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 corporation’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 Canada’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 Canada’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 Canada’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. Today’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, Obama’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. Canada’s federal and provincial governments should keep this revenue by halting their corporate tax cuts.

2 comments

  • The basic argument for lower corporate tax rates is that they will attract multinational firms to locate operations here as opposed to other jurisdictions.

    That’s not an argument I’ve heard. The basic argument is that it will attract capital from investors. What this plan does is make US corporations a less attractive mechanism for US investors to take advantage of investment opportunities in Canada. If anything, this will strengthen the position of Canadian-based firms: capital will flow through them, and not the US multinationals.

    Not that the nationality of the firm matters, of course.

  • Please evaluate possibility of reforming of the canadian taxation system based on the US patent application (http://www.faqs.org/patents/app/20100023433). This government revenue collection system is based on single source Business Levy on Gross Business Revenues. According to my calculations the rate will be at around 33% to provide stable revenues for all levels of government. Is easy to implement. Can save tens of billion of dollars on the cost of administration of all taxes and fees. Eliminates all other taxes and fees, like capital gain tax, interest income tax, payroll deductions and so on. The salaries at the time of introduction of new system will be paid net after all former deductions. Provides automatic collection and distribution of funds to all entities finance by budgets. Eliminates all income tax regulations for business and individuals. New Business Levy regulations will not be longer than 30 pages.

    This system will be popular with voters:
    – no more property taxes
    – no more tax returns
    – more privacy
    – more services from government for the same amount of tax burden.
    – no interest income taxes
    – no capital gain taxes

    This system will be popular with businesses:
    – no significant change in the price of product/service structure
    – only one tax source to administer
    – huge savings in accounting and legal costs
    – no capital gain tax
    – no interest income tax
    – no all other taxes and fees
    – no property tax
    – no tax consequences for buying or selling business
    – no tax on business transfer to a new generation

    This system will be popular with governments:
    – stable source of revenues (based on GDP not income and sale taxes)
    – billions dollars of savings on the cost of administration
    – saving can be used to finance other programs with more benefits to society.
    – Party which adopts it as election platform will get a landslide victory in elections
    – positive attitude of citizens towards government
    – government can concentrate on governing not revenue collection
    – automatic collection and distribution of funds
    – Canada will become a destination for international business
    – Canada will become a destination for capital and retirement place for wealthy individuals
    – Canada will become a economic leader of the world.

    There are already some MPs interested in implementation of this system

    Sincerely,

    Richard Hombek, Ph.D.
    613 329-1062 or richard_hombek@hotmail.com

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