Today is Inauguration Day in the United States. Joseph R. Biden Jr. is now the Official Resident of the White House as President of the United States, and Kamala Harris is the Vice President. It is clear that at this turbulent point in the United States there are many unknowns, including the future direction of US tax policy. It is natural for Canadian companies, investors, and tax professionals to ask themselves what a Biden government could mean to them. This update provides an overview of the legal outlook and the specific proposals made under the Biden platform that are most relevant to cross-border tax planning. We also share our views on the potential impact of these changes on tax structuring and planning in the Canada-US cross-border context.
What is the outlook for tax changes in the US? Do the Democrats have enough votes to pass tax laws?
November did not deliver the "blue wave" many had predicted and softened the legislative ambitions that many Democrats in the United States had. However, the (too many) surprise results of the January 5 runoff in Georgia resulted in a 50/50 split in the Senate, and under the rules of the U.S. Senate, the Vice President (in her capacity as President of the Senate) is entitled to a Cast the groundbreaking vote. This smallest majority in the Senate, coupled with a small majority in the House of Representatives, gives the Democrats control over both legislative houses.
While the passage of laws by the U.S. Senate generally requires a majority of the vote, the much-lauded filibuster can be used by senators to effectively prevent a bill from going to a vote unless there are 60 Senate votes to get it to close the debate and override the filibuster. Accordingly, while Democrats have enough votes to pass a law (with no support from either party), they don't have enough votes to end a filibuster. It is important that there is a legislative process in place that is immune to filibuster challenges and is known as budget reconciliation. The budget reconciliation, which can be used once per budget year, can be used to drive legislation on budgetary issues, including revenue generation and expenditure. The budget voting process is subject to a number of secret rules and restrictions that undermine its effectiveness (including a requirement that the bill have no net budget deficit effect over a 10 year period). Despite these unwieldy restrictions, some of the most important pieces of legislation in recent times, including the Affordable Care Act (i.e. Obamacare) in 2010 and U.S. tax reform in 2017, were passed through a budget vote.
If all Democratic lawmakers stay united, Democrats will have a way to pass tax and spending laws without a single Republican vote. Whether or not they do so is likely to depend on the legislative priorities of the Biden administration and whether, despite all odds, the president and vice president can build enough bipartisan support to avoid having to legislate through a budget vote.
Another aggravating dynamic to consider in future changes to U.S. tax law is the fact that some of the key provisions of President Trump's tax reform law are due to expire in the near future. These "pre-planned" changes in tax law will create a challenging and changing legislative landscape that can affect and even limit what the Biden government can achieve in practice through budget reconciliation.
What tax changes in the US is the Biden government considering?
The Biden presidential platform did not formulate a clear and unified vision for tax policy. However, a number of important proposals can be made up of various statements and declarations made during the presidential campaign. All the initiatives proposed by President Biden so far have been articulated at a high level and in vague language. As a result, the exact contours that these proposals can take are unknown. With these caveats aside, we believe that the top Biden suggestions for Canadian companies and investors are:
- Increase in the corporate tax rate from 21% to 28%.
- Impose a minimum tax of 15% on book income for companies with book income in excess of $ 100 million. Corporations would pay the higher of their regular corporate income tax or the minimum 15% tax (still taking into account the net operating loss and foreign tax credits).
- Double the tax rate on global low intangible tax income (GILTI) of foreign subsidiaries of US companies from 10.5% to 21%.
- Make significant structural changes to the GILTI regime by (a) applying GILTI on a country basis (thereby prohibiting the mixing of GILTI calculations between high tax and low tax areas, which often helps taxpayers reduce GILTI risk) and b) repeal the exemption from GILTI for an amount of income equivalent to a 10% return on certain qualified business goods.
- Imposing a 10% surcharge on companies that move manufacturing or service contracts offshore and sell products or services back to the US market. At a corporate tax rate of 28%, this surcharge would increase the effective corporate tax rate for this activity to approximately 30.8%.
- Extending a 10% Made in America tax credit for activities that restore production, revitalize existing closed or closed facilities, retool facilities to increase employment in manufacturing, or expand payroll in manufacturing.
- Eliminate preferential capital gains and qualifying dividend tax rates for individuals with taxable income greater than $ 1 million and increase the upper limit for individuals from 37% to 39.6% (pre-Trump tax reform).
- Eliminate fossil fuel tax preferences and expand incentives / credits for green technologies.
In addition to legislative action, the Biden government will also be able to shape tax policy through the executive legislative action. Once sworn in, the President is expected to issue an executive order immediately freezing all current regulatory measures pending further review by the new administration.
What do the Biden proposals mean for Canadians?
While it's too early to say which political goals the Biden government will prioritize, it seems relatively clear that if the government cannot form a non-partisan coalition (a Herculean task in recent years), politics by way of a budget vote. If the Biden government uses voting to pass spending programs (e.g. an infrastructure program), it needs a solid set of provisions to increase revenue to ensure that the bill has no net overall budget deficit impact for a period of time 10 years. If things head in this direction, Canadians should expect some of the revenue-generating measures outlined above to be seriously pursued. In this case, there are a few key things Canadians should be prepared for:
- Rate reversal. A rise in US corporate tax rates to 28% would in many cases largely reverse the tax break US companies currently enjoy over Canadian companies. This would have profound implications for the “direction” of cross-border tax planning, as Canadian companies may once again find it more beneficial to reap US deductions and income inclusions in Canada (rather than the opposite of the post-Trump tax reform dynamics). Such a shift in relative interest positions between Canada and the United States could destabilize existing structures and very well reverse the flow of a variety of corporate and transfer pricing decision points. Canadian companies with US subsidiaries would be wise to immediately consider contingency planning for these scenarios (including potentially accelerating income or deferring deductions).
- The effects of the interest rate reversal worsen. For large companies (i.e., companies with book income greater than $ 100 million), the 15% book income tax can exacerbate the problem described in point 1. The introduction of a 15% tax on an income base based on book income (as opposed to taxable income) is expected to reinforce the rise in the effective tax rate of U.S. companies and reinforce the cross-border dynamics described above (ex . Create an incentive to dedicate more of the deductible costs to US operations).
- GILTI is becoming more threatening. The increase in the tax rate for GILTI to 21% and the proposed change to the GILTI rules described above would significantly increase the tax impact of GILTI on the overseas business of US-based groups. As a result, the present value of post-tax returns from abroad would decrease and US-based companies would become more complex. While these changes may remove some of the incentives for US companies to relocate intellectual property and business outside of the US, they run the risk of (a) US-based companies at a competitive disadvantage versus foreign parents (b) Reintroduce strong incentives for US companies to emigrate.
- Reviving the inversion. The changes outlined above are expected to reintroduce many of the incentives – which were known to be widespread prior to the US tax reform – for US corporate groups to turn around and not become US parent groups in order to avoid higher tax rates that US tax complexity and compliance burdens are excessive. For example, cross-border mergers and acquisitions in Canada and the United States would reinvigorate tax incentives to ensure that the combined company has Canadian parents (as opposed to US parents). This dynamic could, in turn, weigh more heavily on US anti-inversion tax regulations and encourage the Biden government to tighten those regulations even further. An escalation of the already massive anti-inversion rules would likely cause collateral damage to “regular” cross-border deals. Even more cross-border transactions could inadvertently fall within the scope of the anti-inversion rules, which would lead to more tax “friction” when structuring cross-border transactions.
- Where to start a newco. In the emerging business space, the Biden proposals would also likely create greater incentives for entrepreneurs to start their business in companies outside of the United States rather than in US companies.
It is clear that we are at the beginning of a new chapter in American politics. There are currently several unknowns as to the priorities the Biden government will set for itself, but it seems relatively clear that the legislative pathways are tight and spending (and therefore revenue growth) will play a prominent role. Canadian companies would be well advised to review the suggestions above and how they might affect their particular circumstances. You should now think about contingency planning that can be implemented quickly if it looks like the Biden government is tracking these changes in tax law. As we have seen in the recent past, a tax change is likely to be quick and those who are prepared for it will steer it more gracefully.