Francisco A. Laguna & Annapurna Nandyal
The United States of America and Canada are two of the largest countries in the world and share the longest international border. The countries share many similarities, including being each other’s chief economic partner. Since the inception of USA-Canada Free Trade Agreement in 1987, huge quantities of goods and services flow across the border each year. The impact of such free trade has been mutually beneficial and serves as an example of how partners can gain from opening their borders to trade. Besides sharing extensive trade ties, both countries share similar economies and have similar taxation structure,
though rates on individuals and corporates are quite different. Canada is a smaller market than the US. To attract new corporate investment and jobs, it has introduced friendly corporate tax schemes which have proved attractive to business. According to a recent KPMG survey, Canada has the lowest overall tax rate on business investment in the Group of Seven Industrialized Nations (G7), after factoring deductions and credits. In comparison, the US has the highest corporate tax rate among the Organization of Economic Development (OECD) out of the group’s 34 member countries.
In the US, federal, state and local governments impose some sort of tax or licensing fee on corporations. Federal corporate tax rates range from 15% to 35%, while state and local tax rates vary by jurisdiction. Corporations are also taxed on branch profits, which means that US corporations must pay income tax on their worldwide income, whether or not repatriated. In addition, federal and state alternative minimum taxes are applicable to cap deductions. All told, corporations are charged a combined ~ 40 % for federal, state and
local taxes. Certain corporate formations, such as mergers, acquisitions and liquidations, are not taxable events. Cashing on this loophole, large US-based corporations have merged with corporations in lower-tax countries. On the surface these deals appear routine, however, the US corporation can now shift its headquarters overseas while retaining its material operations in USA, thus protecting significant profits from taxes. In recent years, a number of American companies, as many as 22 since 2011, mainly pharmaceutical and food industries, have relocated outside USA, usually through mergers or acquisitions of a foreign company. The latest highly publicized relocation was Burger King’s move of its headquarters to Canada in August upon its purchase of Canadian coffee chain, Tim Hortons in August of this year.
Until about a decade ago, Canadian corporate tax rates were significantly higher than those in the US. Similar to the US, in Canada, both the federal government and the territories / provinces have taxing authority. In 2000, the combined federal-provincial statutory corporate income tax rate was ~ 46 %, now reduced to 26%. Besides rate cuts, the Canadian government has undertaken business-friendly policies like removing corporate surtaxes and levies on capital. Moreover, Canada’s tax system only taxes corporation on profits resulting from activities in Canada (territorial taxation). In contrast, the US taxes corporations on worldwide income, including the income of their foreign subsidiaries. These combined policies have attracted investment from companies from the US, China, the EU and Japan.
Other large US corporations that have explored possible investments in Canadian corporations include Pfizer and Walgreens. In reaction to Burger King, however, U.S. Treasury Department has announced plans to crackdown on such corporate deals where the main intent is to evade US taxes. This, however, requires a change in existing tax law, which may not be easy to accomplish.