Recently Trump administration and Congressional Republican leaders released the Unified Framework with regards to the U.S tax reform. This Framework has highlighted the major changes including lower personal tax rates, higher deduction and exemption limits, as well as cutting corporate taxes.
SDG Accountant prepares this article with the intention of providing a brief summary with implications on the impacts for Canadian Business Owners regarding the U.S tax reform. If you would like to know more details about this tax reform or how the tax reform will affect your business, you can reach out to us at 1-416-755-3000 or email at [email protected].
U.S. Tax Reform for Cutting Taxes for Both Individuals and Corporations
According to the Unified Framework released on September 27, 2017
- The business tax rate has been reduced from 35% to 20%;
- Business Profit earned through pass-through entities such as partnerships has reduced from 39.6% to 25%.
Implications
Canadian businesses are eligible to claim the foreign tax credit for the amount of taxes they paid to U.S. tax legislation. As the Canadian corporate tax rate is usually higher than the U.S., the decline in the U.S. tax rate won’t affect the total amount of tax liability for Canadian businesses. Following is an example for demonstration,
| Before U.S. Tax Cut | After U.S. Tax Cut | |
|---|---|---|
| Business Income | $100,000 | $100,000 |
| U.S. Tax | (35,000) | (20,000) |
| Canadian Tax (about 39% of Business Income) | (39,000) | (39,000) |
| Foreign Tax Credit (equals to foreign tax paid) | 35,000 | 20,000 |
| After-tax Income | 61,000 | 61,000 |
Although the U.S. tax portion has been declined, the foreign tax credit has been reduced correspondingly. Therefore, the net after-tax income for Canadian businesses remains unchanged.
Potential Limitation on Interest Deductibility
The framework has mentioned that interest deductibility would be limited. This will impact Canadian companies using Debt Finance at U.S. operations. Usually, Multinational Enterprise uses debt financing to leverage the tax benefit of deducting interest expense at U.S. subsidiaries. In addition, debt financing can also avoid dividend withholding tax when repatriating income.
Implication
Although the Canadian Parent Company needs to pay property income tax streaming from the Subsidiary loan, the U.S. subsidiary can reduce its tax liability by deducting the interest expense which will result in a tax-neutral position.
According to the indications from tax reform, U.S. subsidiaries might not be eligible to deduct the interest expense. This means the Canadian Parent Company will continue to accrue interest income but the U.S. subsidiary is not able to reduce income tax liability by deducting the interest expense. Thus, Canada’s overall tax liability has increased.
This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.
— Andrew Chen
October 10, 2017
