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U.S. tax reforms present challenges

Focus on: Tax Law
|Written By Jim Middlemiss
U.S. tax reforms present challenges
Scott Semer says the U.S. move to slash its corporate tax rate will ‘push a lot of governments to consider lowering their tax rates or certainly not to raise them.’

Tax lawyers say recent U.S. tax changes will present challenges for Canadian companies operating south of the border and U.S. subsidiaries operating here.

That could be bad news when it comes to Canada’s competitiveness with its largest trading partner, spurring calls for the federal government to review Canada’s overall tax policy.

In fact, some business groups have warned that the U.S. tax changes could hurt Canada’s economy more than a NAFTA pullout.

Paul Seraganian, New York managing partner at Osler Hoskin & Harcourt LLP, says the U.S. Tax Cuts and Jobs Act “has changed the cost benefit analysis of investing in the U.S. It means there will be a capital shift at the margins away from Canada and into the U.S.

“I think they [the government] will have to consider seriously whether changes to Canada’s own system are needed to try to make it more attractive to bring jobs and capital investment back into Canada,” he says.

Scott Semer, a tax partner in Torys LLP’s New York office, says the U.S. move to slash its corporate rate to 21 per cent from 35 per cent will “push a lot of governments to consider lowering their tax rates or certainly not to raise them.

“It’s almost a 50-per-cent rate cut. That’s a pretty big cut,” he says.

Semer says that, prior to the cuts — the legislation was passed just before Christmas — the U.S. had one of the highest corporate tax rates among countries that are members of the Organisation for Economic Co-operation and Development. The OECD average is closer to 20 per cent, he says, adding that both Canada and the U.S. were “outliers.”

The tax cuts are being hailed as the biggest tax reform since the years when U.S. president Ronald Reagan was in office, from 1981 to 1989.

“It’s in the same zip code as that,” says Seraganian.

“It’s a very, very huge event.”

He adds that “it’s going to take a while to see exactly what happens.

“These changes run so deep, they might change behaviours in a way that can’t be fully predicted,” he says.

In less than a month, though, the impact was being felt across the U.S. economy. A growing number of U.S. companies are sharing the wealth with their employees, either through raises or bonuses. As well, the law allows U.S. companies to repatriate cash from overseas at reduced tax rates, as low as eight per cent. U.S. companies hold as much as US$2.6 trillion offshore, reluctant to repatriate it because of the then-high tax rate. Already, some companies are taking advantage of the opportunity to pay less tax on their offshore holdings. 

Apple Inc. has announced it will pay U.S.$38 billion, likely the single biggest tax payment ever to the U.S. Treasury, to repatriate US$245 billion it holds overseas and it will use that money to create 20,000 new jobs over the next five years, as part of what it calls a “[US]$350-billion contribution” to the U.S. economy.

The impact is being felt on this side of the border, as a number of cross-border companies book one-time charges to reflect the impact the reforms have on deferred tax assets.

Manulife announced in a statement that it would take a $19-billion charge in the fourth quarter. 

“The estimated amount of the charge reflects the impact of U.S. tax reform on policyholder liabilities and deferred tax assets which includes the lowering of the U.S. corporate tax rate from 35 per cent to 21 per cent and limits on the tax deductibility of reserves,” according to a press release by the company.

Seraganian says the changes will impact Canadian companies operating in the U.S. In an update from the firm, Osler noted that, “given the extreme interconnectivity between the Canadian and U.S. markets, both U.S.-inbound and U.S.-outbound rules can have important consequences for Canadian business.

“[C]anadian businesses operating in the cross-border space should systematically rethink their cross-border arrangements from the ground up and realistically assess their continuing value to the enterprise,” said the note.

“In some cases, no action will be merited but, in others, unwinds should be considered.”

Seraganian says Canadian companies with U.S. subsidiaries would be wise to “go back to the drawing board in terms of their game plan.” That’s because he says the reform has “changed the landscape” and “affects a lot of choices” that companies have made in their structure and the way they finance their U.S. operations, which could now be negatively impacted.

New tax base erosion provisions also mean U.S. companies that make deductible payments to a related foreign parent or subsidiary could be subject to an excise tax.

“It’s designed in part to encourage people to do more stuff in the United States and protect the U.S. tax base,” says Semer.

There is “a lot of interest from investors who think it is going to be a pretty good time to invest in the U.S. as opposed to outbound,” says Semer, who focuses on inbound investment into the U.S.

“The big takeaway to watch for is does the U.S. become a more attractive place to headquarter international business and does the U.S. become a more attractive place for investors than Canada and other jurisdictions because of the lower tax burden?” he says.

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