The U.S. is open for business. This is the message president-elect Donald Trump’s proposed tax policies make loud and clear. For Canadian corporations and individuals, the reforms are largely favourable and present the potential for tax savings—if they are enacted. Another caveat: the Trump proposals have been presented in broad strokes, with little in the way of detail, particularly when it comes to how and when they will be implemented.
With that said, what can the world expect when Donald Trump becomes the 45th President of the United States on January 20, 2017? In a nutshell, aggressively lower tax rates across the board. There is a majority of Republicans in the U.S. House of Representatives, and a tax reform blueprint was published by the Speaker of the House of Representatives in June, 2016. In this article, we also make reference to this “House Blueprint” document as a point of comparison to key action items of the Trump plan.
For businesses, this means a more competitive corporate tax rate designed to make it less expensive to do business in the U.S. Currently, the average federal tax rate for corporations is 35%. Trump has promised to lower this to 15%—below the House Blueprint’s proposed 20%. This rate will be available to all businesses, regardless of size, and also, by election, to pass-through businesses such as partnerships. Of course the effective tax rate for U.S. business income also depends on the applicable state tax rate, and state tax rates vary from state to state. For many Canadian corporations, top corporate tax rates including provincial tax range from 26% to 31%, for an average of about 27%. For these corporations, it may be worth considering restructuring or opening a subsidiary in the U.S. to take advantage of the lower U.S. federal rates, if the overall U.S. tax rate, including state taxes, will be lower than the effective Canadian tax rate.
Initiatives to lower corporate tax rates have strong support in the U.S., which means the new administration will likely move forward with this reform.
Trump and the House Blueprint also appear to be on the same page when it comes to the deductibility of business interest. According to Trump’s campaign website, manufacturers in the U.S. can elect to benefit from a full expensing of capital investment in year one. However, businesses that make the expensing election would lose their ability to deduct interest expense.
Any policy changes to business interest deductibility may impact financing arrangements of Canadian corporations with U.S. subsidiaries that advance loans to those subsidiaries. Currently if interest is charged on those loans, the subsidiary’s income is lowered and the interest income is recorded in the lower tax jurisdiction, which today is Canada. Under Trump’s plan, interest expense would be deductible against interest income only with no deduction for net interest expense.
Trump has also proposed that income from carried interest, which private equity fund managers receive as a form of compensation, be taxed as ordinary income. It would then be subject to the top rate of 33% under his plan, as opposed to being taxed 23.8% as a capital gain. However, for pass-through businesses, this would be offset by the much-reduced tax rate of 15%, a savings of about one-third.
Another key campaign promise: In an attempt to recoup some of the estimated US$2.9 trillion in corporate profits held offshore, Trump promised U.S. companies would get a one-time tax rate of 10% to repatriate those funds. Currently, U.S. companies must pay the difference between what they have already paid in foreign taxes and the U.S. rate if they return that money to the U.S. It’s unclear just how this proposed change will affect a decision to repatriate profits from Canadian subsidiaries.
Trump’s plan, like the House Blueprint, calls for repealing the corporate alternative minimum tax (AMT). No details have been provided by either Trump or the House Blueprint with respect to what will happen to AMT credits accumulated prior to repeal.
Perhaps the most controversial proposal from Trump’s tax plan is to tax all goods and services entering the U.S. while avoiding taxing any goods or services exiting the U.S. This destination tax, as it is being called, is in support of Trump’s biggest campaign pledge to keep manufacturing jobs in the U.S. According to media reports, economists from Goldman Sachs believe there is a one in three chance the proposal will be approved. The destination tax, if enacted, may have significant impact for Canadian businesses which are currently able to utilize trade agreements to sell and ship their goods to the U.S. “tax-free”.
For individuals, Trump’s tax plan promises to cut tax rates and simplify tax reporting by reducing the number of tax rates from seven, under current law, to three. According to his campaign website, the brackets and rates for married joint filers would be as follows: less than $75,000, 12%; more than $75,000 but less than $225,000, 25%; and more than $225,000, 33%. Brackets for single filers are proposed to be half of these amounts.
Expats living in Canada generally pay more Canadian tax than they would pay in the U.S., so these reduced U.S. rates likely won’t result in any reduction in overall taxes paid by these individuals. However, they may provide an incentive for U.S. citizens living in Canada to return to the U.S. Also, lower U.S. personal taxes, combined with recent increases in Canadian taxes on high income earners, may provide an incentive for highly-paid Canadian employees, professionals and business owners to move to the U.S.
As well, while these proposed changes may simplify tax reporting for people living and working in the U.S., they won’t help U.S. taxpayers living in Canada or elsewhere outside the U.S. There has been no indication from Trump that he intends to reduce the significant compliance burden for expats. This compliance burden includes filing U.S. income tax returns and other reporting forms on an annual basis, including reports of bank accounts and investments located in foreign countries. There has been no indication that these reporting requirements will change.
The existing capital gains rate structure, with its maximum rate of 20% will remain unchanged. Carried interest will be taxed as ordinary income. Trump also promised to repeal the 3.8% Obamacare tax on investment income and the alternative minimum tax. The repeal of this tax could be beneficial for high-income U.S. citizens living in Canada.
In addition to the reduction of topline rates, Trump’s tax plan calls for significantly increasing the standard deduction to $15,000 for individual filers and $30,000 for joint filers. He has also announced his intention to cap the amount of itemized deductions to $100,000 for single filers and $200,000 for joint filers.
Both Trump and the House Blueprint have stated they would repeal the estate tax regime in U.S., but neither has provided any information about what might replace it, if anything. However, this fall Trump proposed that capital gains on assets held until death and valued over $10 million will be subject to tax. This is an area expats living in Canada and Canadian citizens who own property in the U.S. should watch closely.
Bottom line, both Trump and the Republican Party’s House Blueprint laid out broad outlines of what they want to do. In a nutshell, the plan comes down to reducing taxes, broadening the tax base and simplifying tax filing. The proposal with the most significant impact for Canadian corporations and U.S. citizens living in Canada is Trump’s promise to reduce the corporate tax rate, which may have a consequential effect for expats who now reside north of the border. The world should start to see how his plan unfolds and gain a better sense of which policies will be enacted in his first 100 days in office and as he enters into budget discussions. In the meantime, stay calm and carry on.
For more information on this or other issues facing your business, please contact your local BDO office or one of our key contacts for U.S. Tax (click here):
Rick Leaker, CPA, CA
Senior Manager, U.S. Tax
780 643 8980
Joanna Kalin, MBA
Manager, U.S. Tax
The information in this publication is current as of January 3, 2017.
This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.