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MNP's TAKE: A sweeping tax reform proposal brought forward by Republican members of the House of Representatives tax committee is sure to have a significant impact on Canadian businesses relying on exports.
Often framed as an issue of U.S. non-competitiveness, it is important to view the current U.S. federal corporate tax regime in perspective. While U.S. federal corporate tax rates are some of the highest in the world (35%), studies performed by the U.S. Government Accountability Office concluded that the effective tax rate for profitable large U.S. corporations was less than 20%.
A border tax adjustment (as part of the Better Way agenda) would tax imported goods and services at a rate of 20%, with exemptions for profits earned outside of the U.S. Also included with the 2016 U.S. House Republican Tax Reform Plan is the denial of net interest expense on debt, which is often used to shift profits from the U.S to a lower tax jurisdiction. This is coupled with immediate expensing of capital investments.
While the border tax adjustment is currently not supported by President Trump, Republican lawmakers are making significant efforts to include it with U.S. federal corporate tax overhaul, in order to pay for the significant reduction in tax rates that both President Trump and Republicans agree on.
Considering the fact that in 2015, more than three-quarters of Canada's exports went to the U.S., if border tax adjustments are actually codified, Canadian businesses with exports or distributors in the U.S. could be adversely affected. Proponents of a border tax adjustment point out that the U.S. dollar should appreciate because of the increased competitiveness of U.S. exports offsetting the effect of the 20% tax on imports. Whether theory follows reality will determine the true impact for Canadian businesses with U.S. exports
For more information on how a cross-border tax adjustment could impact you and your business, contact Sidhartha Rao JD, LL.M., International Tax Services at 604.685.8408 or [email protected]
BY ANDREI SULZENKO FROM THE GLOBE AND MAIL
Executive fellow at the School of Public Policy, University of Calgary
It is difficult to discern what president-elect Donald Trump’s tweets regarding a “border tax adjustment” are about, other than further jawboning of U.S. companies.
Adding the word tax to the lexicon on trade does, however, underline the complex interplay of policy instruments and their sometimes unintended consequences.
At a macro level, the U.S. tax system has a number of features that are increasingly at odds with major competitors, including Canada. Personal income-tax rates are low, while corporate income is taxed at a relatively high rate, and there is no federal sales tax. Elsewhere, particularly in Europe, personal taxes tend to be much higher, corporate taxes are much lower and sales taxes can reach 20 per cent.
These differences have a negative impact on U.S. business competitiveness. For one thing, companies such as Apple choose not to repatriate profits (then subject to the difference between high U.S. and lower foreign tax rates) that could be used to stimulate productive investment in the United States.
There is an obvious fix for that – namely lower U.S. corporate rates – and it seems to be a priority for the incoming Trump administration.
The more difficult issue is the lack of a U.S. federal sales tax.
Under international trade rules, sales taxes are applied only to domestic consumption and are either rebated or not applied on exports. That means countries with an emphasis on sales taxes in their policy mix are much more price competitive internationally than countries such as the United States, with an emphasis on income taxes.
Indeed, this situation is the basis for a long-standing grievance by U.S. policy makers about the purportedly inequitable rules of international commerce as adjudicated by the World Trade Organization. From a U.S. perspective, it is unfair that WTO rules permit the rebate of sales taxes (e.g. the GST) on exports, but those rules do not recognize that, in reality, corporate income taxes are similarly passed on to purchasers of goods and services, thereby meriting some form of relief on export.
This means, for example, that exports from the European Union, where the value added tax can reach 20 per cent, are much cheaper in the United States than in the home market.
At the same time, U.S. exports to the EU do not get a tax break because there is no U.S. federal sales tax. In a sense then, the United States is penalized in its trade competitiveness for making legitimate sovereign decisions about the makeup of its overall tax structure – a rigged system?
In response to this perceived inequity, in the early 1970s, the Nixon administration promoted the establishment of the Domestic International Sales Corporation (DISC) program. Under DISC, U.S. companies could establish foreign sales subsidiaries, essentially shell companies that were taxed at a lower corporate rate. Of course, U.S. trading partners protested long and hard. Indeed, Canada’s early policy offset was to initiate an accelerated, two-year writeoff for manufacturing and processing investments while joining in the trade litigation.
DISC was found to be illegal under the WTO’s predecessor, the General Agreement on Tariffs and Trade. The United States replaced it with a similar instrument called the Foreign Sales Corporation (FSC), but that, too, was found to be an illegal export subsidy by the WTO and was subsequently repealed in 2000.
It does not end there, however, as the FSC statute was replaced by new provisions of essentially equivalent effect. The EU challenged again and won, with the WTO-sanctioned ability to impose $4-billion in punitive trade measures in the event of further U.S. non-compliance. The issue remains a standoff as retaliation was judged by the EU as not likely to change U.S. policy while shooting itself in the foot.
The point of this historical anecdote is that “exceptionalism” seems to be hardwired into the American psyche and will brook no compromise when a policy, in this particular case taxation, is believed to be fundamentally right and just. It matters little that the international norm is the exact opposite. It is still wrongheaded. Sound familiar in relation to the recent rhetoric on trade?
The problem with ideology trumping analysis is that the U.S. risks failing to achieve its jobs and growth objectives. In this case, it may not occur to Republican policy makers that good economic policy involves taxing consumption relative to income.
(Remember the controversy in Canada on lowering the GST?) Indeed, even if that approach is actually considered, it will probably be deemed to be a non-starter – as un-American as gun control.
Too bad, because a U.S. federal sales tax (rebated on exports) would go a long way in legitimately levelling the international playing field. It sure beats any one of an array of “border tax adjustment” measures of dubious legality that will undoubtedly invite retaliation and make everyone worse off. That’s shooting yourself higher than in the foot.
This article was written by Andrei Sulzenko from The Globe And Mail and was legally licensed through the NewsCred publisher network.
Related Topics:International Tax; U.S. Tax; Government
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