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 Vice President. Clearly, there are many unknowns at this tumultuous juncture in the United States and, among them, is the future direction of U.S. tax policy. It is natural for Canadian businesses, investors and tax professionals to be asking the question of what a Biden administration may mean for them. This Update provides an overview of the legislative outlook and the specific proposals that have been advanced as part of the Biden platform that are most relevant to cross-border tax planning. We also share our views on the potential impact these changes could have on tax structuring and planning in the Canada-U.S. cross-border context.
What are the prospects for tax law changes in the United States? Do the Democrats have enough votes to pass tax legislation?
November did not deliver the "blue wave" that many had predicted, tempering the legislative ambitions that had been harboured by many Democrats in the United States. However, the surprise (to many) results of the Georgia runoff elections on January 5 created a 50/50 split in the Senate and, under U.S. Senate rules, the Vice President (in her capacity as President of the Senate) is entitled to cast the tie-breaking vote. This slimmest of majorities in the Senate, coupled with a small majority in the House of Representatives, gives the Democrats control of both legislative houses.
While passing laws through the U.S. Senate generally requires a majority of votes, the much-vaunted filibuster can be used by senators to effectively prevent a bill from coming to a vote unless there are 60 Senate votes to close out debate and override the filibuster. Accordingly, while Democrats have enough votes to pass a bill (without bipartisan support), they do not have enough votes to end a filibuster. Importantly, there is a legislative process that is immune from filibuster challenge, known as budget reconciliation. Budget reconciliation, which can be used once per budget year, can be used to advance legislation related to budgetary matters, including both revenue raising and spending. The budget reconciliation process is subject to a number of arcane rules and limitations that impair its effectiveness (including a requirement that the bill has no net impact on the budget deficit over a 10-year budgetary window). Despite these unwieldy restrictions, some of the most consequential legislative enactments in recent memory, including the Affordable Care Act (i.e., Obamacare) in 2010 and U.S. Tax Reform in 2017, were passed by way of budget reconciliation.
As such, if all democratic lawmakers stay unified, the Democrats do have a path for enacting tax and spending legislation without a single republican vote. Whether or not they do this will likely depend on the Biden administration's legislative priorities and on whether the President and Vice President can, against the odds, build enough bipartisan support to avoid having to legislate by way of budget reconciliation.
Another complicating dynamic to keep in mind when thinking about future changes in U.S. tax law is the fact that a number of the key provisions of President Trump's tax reform bill are scheduled to expire in the near future. These "prescheduled" changes in tax law will create a challenging and shifting legislative landscape that may influence, and even limit, what the Biden administration can practically accomplish by way of budget reconciliation.
What U.S. tax changes are the Biden administration considering?
The Biden presidential platform did not articulate a clear and unified vision for tax policy. However, a number of key proposals can be cobbled together from various pronouncements and statements made during the presidential campaign. All of President Biden's proposed initiatives have, to this point, been articulated at a high level and with vague language. As a result, the precise contours that these proposals may take are unknown. With these caveats aside, we believe that the most important Biden proposals to Canadian businesses and investors are the following:
- Increasing the corporate tax rate from 21% to 28%.
- Imposing a minimum tax of 15% on the book income of corporations with book income in excess of $100 million. Corporations would pay the greater of their regular corporate income tax or the 15% minimum tax (while still allowing for net operating loss and foreign tax credits).
- Doubling the tax rate on global intangible low-taxed income (GILTI) earned by foreign subsidiaries of U.S. corporations from 10.5% to 21%.
- Making significant structural modifications to the GILTI regime through (a) applying GILTI on a country-by-country basis (thereby prohibiting the blending of GILTI computations between high-tax and low-tax jurisdictions, which frequently helps taxpayers reduce GILTI exposures) and (b) eliminating the exemption from GILTI for an amount of income equal to a 10% return on certain qualified business assets.
- Imposing a 10% surtax on corporations that move manufacturing or service jobs offshore and that sell products or services back into the U.S. market. This surtax would, assuming a corporate tax rate of 28%, increase the effective corporate tax rate on this activity to approximately 30.8%.
- Extending a 10% "made in America" tax credit for activities that restore production, revitalize existing closed or closing facilities, retool facilities to advance manufacturing employment, or expand manufacturing payroll.
- Eliminating preferred capital gains and qualified dividend tax rates for individuals with taxable income over $1 million and increasing the top marginal rate bracket for individuals from 37% to 39.6% (where it was before the Trump tax reform).
- Eliminating tax preferences for fossil fuels and expanding incentives/credits for green technology.
In addition to legislative action, the Biden administration will also be able to shape tax policy through the executive action of issuing regulations. It is expected that, upon being sworn in, the President will issue an immediate executive order that freezes all current regulatory actions pending further review by the new administration.
What do the Biden proposals mean for Canadians?
While it is too early to tell which policy objectives the Biden administration will prioritize, it seems relatively clear that if the administration cannot build a bipartisan coalition (a Herculean task in recent years), it will need to enact policy legislatively by way of budget reconciliation. If the Biden administration uses reconciliation to enact spending programs (such as an infrastructure program), it will need a robust collection of revenue-raising provisions in order to ensure that the bill, as a whole, has no net effect on the budget deficit over a 10-year period. If things trend in this direction, Canadians should expect several of the revenue-generating measures described above to be seriously pursued. In this case, there are a few key things that Canadians should be prepared for:
- Rate reversal. An increase in U.S. corporate tax rates to 28% would in many cases largely reverse the rate advantage that U.S. corporations currently enjoy over Canadian corporations. This would have a deep-seated impact on the "directionality" of cross-border tax planning in that Canadian companies may once again view it as more beneficial to harvest deductions in the U.S. and income inclusions in Canada (rather than the opposite, which was the dynamic that emerged after Trump's tax reform). Such a shift in the relative rate positions between Canada and the United States could destabilize existing structures and very well reverse the flow of a host of inter-company transactions and transfer pricing decision points. Canadian companies with U.S. subsidiaries would be well advised to start thinking about contingency planning for these scenarios right now (including, potentially, the acceleration of income or deferral of deductions).
- Compounding the effects of rate reversal. For large businesses (i.e., those with more than $100 million of book income) the 15% tax on book income may exacerbate the issue described in point one. Imposing a 15% tax on an income base that is based on book income (as opposed to taxable income) would be expected to fortify the increase in the effective tax rate of U.S. corporations and reinforce the cross-border dynamics described above (e.g., create an incentive to allocate a greater proportion of deductible expense to U.S. operations).
- GILTI becomes more menacing. The increase in the tax rate on GILTI to 21% and the proposed modification of the GILTI rules described above would significantly increase the tax impact that GILTI has on foreign operations of U.S.-based groups. This would have the effect of decreasing the present value of after-tax returns from foreign operations and burdening U.S.-based companies with greater complexity. While these changes may have the effect of removing some of the incentives for U.S. companies to move IP and operations outside the United States, it would do so at the risk of (a) placing U.S.-parented businesses at a competitive disadvantage to foreign-parented businesses and (b) reintroducing powerful incentives for U.S. corporations to expatriate.
- Inversion revival. The changes described above would be expected to reintroduce many of the incentives — which were famously prevalent before U.S. tax reform — for U.S.-parented corporate groups to "invert" and become non-U.S.-parented groups in order to escape higher tax rates, excessive U.S. tax complexity and compliance burdens. For example, in Canada-U.S. cross-border M&A, there would be renewed tax incentives for ensuring that the combined company was Canadian parented (as opposed to U.S. parented). In turn, these dynamics could put greater strain on the U.S. anti-inversion tax rules and incentivize the Biden administration to tighten these rules even further. An escalation of the already formidable anti-inversion rules would likely impose collateral damage on "regular" cross-border deals. Even more cross-border transactions would risk becoming inadvertently swept into the ambit of the anti-inversion rules, creating more tax "friction" in structuring cross-border deals.
- Where to form a Newco. In the emerging companies area, the Biden proposals would also likely create greater incentives for entrepreneurs to start their businesses in non-U.S. companies, rather than U.S. companies.
It is clear that we are at the beginning of a new chapter in American policymaking. There are currently several unknowns regarding the priorities that the Biden administration will set for itself, but it seems relatively clear that the legislative paths are narrow, and spending (and therefore revenue raising) will feature prominently. Canadian companies would be well-served to consider the proposals outlined above and how they could have an impact regarding their particular circumstances. They should begin thinking now about contingency planning that can be implemented quickly if it looks like the Biden administration will pursue these tax legislative changes. As we've learned in the recent past, if tax change happens, it will likely happen quickly and those who are prepared will navigate it more gracefully.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.