Corporate Income Tax & US Policy Changes – Christians

By Allison Christians

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Canada is in the midst of a period of strengthening the health and sustainability of the corporate income tax. Internationally, there is a campaign underway to ensure that companies declare profits and pay taxes where they create value, rather than diverting income to jurisdictions where it is more lightly taxed. This initiative, designed to curb “Base Erosion and Profit Shifting,” or BEPS, has been met with measured enthusiasm by Canada’s lawmakers, who understand Canada’s best interests to lie in cautious and steady moves in the direction of global consensus without going too far, too fast, in such a way as to scare off foreign capital. Closer to home, on the other hand, the United States, after putting its unique print on the BEPS project, has signalled some reluctance to follow through and recently floated a proposal to eliminate corporate taxation all together in favour of switching to a so-called destination-based cash flow tax (“DBCFT”).

Owing to the current political climate in the U.S., the switch to a DBCFT is a remote possibility at this time, but the prospect of future reform along the same lines raises concerns about the ongoing viability of the Canadian corporate tax system were such an event to occur. These concerns are justifiable given a century of tailoring Canada’s corporate tax rules to a world of loosely aligned systems of income taxation in which Canada has focused on making itself a strong competitor to its comparatively much more economically powerful neighbour, even while working cooperatively and harmoniously with the United States and the rest of the world to ensure the integrity and longevity of the income tax as a whole. If the United States now or in the future takes a strong tack away from the international tax system it has helped craft over a century, how might Canada cope?

Some lessons from Canada’s past experience in studying the corporate tax system and assessing the need for major overhaul may serve as a useful point of departure. A major study took place in 1996, when the Minister of Finance appointed a Technical Committee on Business Taxation to review the Canadian business taxation system, chaired by Jack M. Mintz. The committee report highlighted the difficulty involved in balancing basically incompatible policy goals in the design of the corporate income tax:

“Tax policies related to inbound and outbound investment are driven by two important objectives: domestic economic growth and job creation on the one hand, and protection of the Canadian revenue base on the other. The Committee recognizes that there are often tension between these two objectives.”

The authors observed that Canada derives “considerable benefit” from the existence of Canadian-headquartered multinational companies, and emphasized that “foreign multinationals operating in Canada provide capital, management and expertise for the development of key sectors of the economy.” The report therefore prioritized “the expansion of such companies, and their foreign investment, with foreign and domestic investors being placed on a similar footing.”

Even while thus proclaiming national support for multinationals in Canada, the report acknowledged that such companies tended to use international financial structures to shift deductible expenses into Canada, thereby eroding the tax base. The report dedicated a section to denouncing aggressive tax competition and the perils of a race to the bottom with the tax system.

Like most studies produced by economists throughout the age of modern taxation, the Mintz report advocated a lower corporate tax rate offset by a broader base and suggested various refinements to the international tax regime, most of which were never implemented. Subsequently, an Advisory Panel on Canada’s System of International Taxation, formed in 2007, revisited the terrain explored by the Mintz committee and proposed further refinements, some of which were ultimately adopted in 2012. In both studies, the researchers concluded that Canada’s regime for taxing multinationals was on solid footing, with the Mintz report observing that Canada’s system was “fundamentally sound and should be maintained,” and the Advisory Panel confirming that it “served Canada well.”

One section of the Mintz report dealt briefly with the possibility of effectuating a major structural change to the Canadian tax system through the adoption of various alternatives to the corporate tax, including a cash flow type tax. The Report considered the likely costs and benefits of switching from a corporate income to a cash flow tax, and ultimately rejected the idea as undesirable owing to the probability that such a change would fundamentally destabilize the entire income tax structure in Canada, as well as introducing a rift with Canada’s major trading partners. Besides destabilizing the personal income tax, the Mintz Report noted the likelihood that, depending on the specific features chosen, a cash flow tax would produce an overall narrower base than that achievable with an income tax.

The overall lesson of the Mintz Report for Canadian corporate tax policy appears to be that for maximum efficacy in a world replete with strong competition for the factors of economic growth and productivity, Canada’s best strategy is to remain stable and consistent in the fundamentals with its major trading partners, and work to achieve a competitive edge within the confines of global consensus as it may evolve from time to time. Canada’s achievement of incremental gains in this competition stand to be immediately lost if a major trading partner like the United States completely overhauls its entire approach to the taxation of multinationals. A switch to DBCFT by the United States would wipe out a lot of the reasons for companies to locate operations in Canada—reasons that had been quietly nurtured through successive reforms of the corporate tax system.
As envisioned in broad strokes, the proposed DBCFT would eliminate the traditional tax results obtained by locating operations outside of the United States—namely the ability to carefully manage repatriation of profits and losses for maximum tax minimization—while making imports more expensive than goods produced within the territory. The proposal therefore poses a threat to direct employment and investment in Canada as well as to the spillovers associated with corporate activity carried out in Canada, as noted in the Mintz Report. At the same time, the DBCFT would render as useless many of the international financial structures set up by Canadian-headquartered companies doing business in the United States. Eliminating corporate tax planning could be a net good in terms of reducing rent-seeking overall, but the real effects on business activity in Canada might cancel those gains.

Perhaps the clearest lesson from the Mintz Report, which is confirmed by the initial reaction of tax experts to the U.S. DBCFT proposal and in the efforts of Canadian representatives to advocate vigorously against its adoption, is that there is a potential for serious and unpredictable upheaval in the Canadian corporate tax base if such a momentous change were to take place in the United States. Accordingly, it will be prudent for Canada to remain vigilant and begin to plan its response to such a change—while the prospects for reform currently seem remote. Change, when it occurs, could occur rapidly and force a more or less immediate response.

Allison Christians is a tax law scholar and the H. Heward Stikeman Chair in Tax Law at McGill University

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