The proposed overhaul of the U.S. tax system is expected to benefit Canadian companies doing business south of the border. The U.S. Senate is set to start its consideration of the Tax Cuts and Jobs Act this week, after House Republicans passed it earlier this month. However, the legislation could also bring bad news for some business owners – Americans living in Canada who own Canadian corporations are worried they could be subject to massive tax bills.
"Things are going to get simpler and more attractive for Canadian businesses doing business in the U.S. and substantially more complicated and expensive for U.S. citizens who own Canadian businesses," if the legislation passes, says Max Reed, a cross-border tax lawyer with SKL Tax.
The proposal to reduce the corporate-tax rate to 20 per cent from 35 per cent will give companies more money to spend and is expected to spur economic activity. The proposal also allows American businesses investing in the United States to write off equipment purchases more quickly, which could boost capital spending. Both measures are considered good news for Canadian businesses selling products and services to American companies.
Barrie, Ont.-based Linear Transfer Automation, which makes specialized automation equipment for the auto sector, is positioning itself for more growth in the United States if the tax proposals are passed. About 70 per cent of its business is in the U.S.
"It's an extremely positive thing for us if it does go through," says Paul Stirrett, Linear's vice-president of sales. "It's simple economics 101 – lower corporate taxes means more spending for capital investment."
While Canadian companies selling into the United States will likely benefit, it could also incentivize some to relocate south of the border to pay less corporate tax, says Dan Kelly, president of the Canadian Federation of Independent Business.
Mr. Kelly says more members are telling him that relocation is tempting given rising costs of doing business in Canada.
"They're looking at the trend line in Canada versus the U.S. and saying, 'Maybe I'm crazy to stay here.' That's the piece we have to worry about the most," Mr. Kelly says. "If the pasture is a lot greener in the U.S., there will be some businesses that will take up the offers they're getting [to relocate south of the border]. There is big money on the table."
American business owners in Canada
The proposed bill generates a one-time tax hit of up to 14 per cent to U.S. citizens who own businesses abroad. Mr. Reed says the tax would be on corporate assets not taxed in the United States since 1986, the last time the U.S. tax code was overhauled, including physical assets such as machinery as well cash, stocks and bonds. The result could be a one-time tax bill of hundreds of thousands of dollars for American business owners who live and work in Canada and pay taxes in both countries. U.S. citizens, no matter where in the world they live, are required to file with the Internal Revenue Service.
Mr. Reed says the proposal targets large multinational corporations but, as proposed, would also include various sized businesses operating outside of the United States.
Going forward, the proposals also call for American citizens who own Canadian businesses to include in their personal income a portion of their active business income each year. Currently, Mr. Reed says, these citizens with active businesses don't pay tax on the company's profits until they take the money out.
"The proposal imposes a new, very complicated set of rules on U.S. citizens that own the majority of a foreign corporation," he says. Those affected would be taxed personally on 50 per cent of the entire income of the Canadian corporation that is above the amount set by a complex formula, Mr. Reed says, adding that it would make compliance for these businesses "extremely complicated and expensive."
Mr. Reed has a number of American clients living in Canada caught up in these proposed changes, some of which are even considering renouncing their U.S. citizenship to avoid the hefty tax hit.
One dual Canadian-American citizen who lives in British Columbia and has owned a business in the province since the late 1990s says his tax bill under the proposed legislation could be as much as $400,000.
"That's a lot of money, and it's out of nowhere," says the business owner, who didn't want his named used for fear of repercussion from U.S. tax authorities.
He believes Americans such as him, living outside of the country, are easy targets because they don't have a constituency south of the border.
"I don't know if it's inadvertent, or they just haven't thought it through," says the business owner, who pays taxes in both the United States and Canada. "They're affecting our lives profoundly when we haven't done anything wrong. They're unfairly taxing people who have done the right thing."
While some have suggested he renounce his citizenship, the process can be complex and expensive. It is also irrevocable. Instead, he's hoping the Canadian government will step in and defend dual citizens such as him who are following the rules.
When asked to respond about whether Ottawa was looking into the issue, a spokesperson from Canada Revenue Agency said the department is "responsible for administering tax and benefits in Canada. It is not the CRA's practice to comment on the tax laws of another country."
Steven Flynn, a partner at cross-border tax firm W.L. Dueck & Co. LLP, says the one-time tax hit can be offset by a foreign tax-credit carry forward, which is excess Canadian taxes paid over U.S. taxes. (The foreign tax-credit system ensures that taxpayers aren't taxed twice on the same income. In general, if two countries are trying to tax the same amount of income, the country where the income was earned taxes the income first.) For instance, if an American business owner in Canada pays $30,000 in tax in Canada, and owes $20,000 in tax in the U.S., the owner would use $20,000 of the $30,000 to reduce the U.S. tax to nothing and the remaining $10,000 is carried over to future years.
"For many U.S. citizens in Canada, they probably have a balance of foreign tax-credit carry forward that will help reduce the bill," he says.
Mr. Flynn also said the tax owed under the new proposal can also be spread out over eight years, instead of paid at once, which could offer some relief to those affected.