Tax Insights: US tax reform bill enacted – What it means for Canadian businesses

December 22, 2017

Issue 2017-51

In brief

Today, President Trump signed the final version of the tax reform legislation (referred to as “HR 1”) into law. HR 1 will implement the most significant overhaul of the US tax code in more than 30 years. 

This Tax Insights discusses how the tax reform legislation impacts Canadian-owned businesses.

In detail

Highlights

The key features of the legislation that are relevant to Canadian-owned businesses include the following domestic and international measures.

Domestic measures

  • The corporate tax rate is permanently reduced to 21% for tax years beginning after 2017. A blended rate will apply for fiscal year taxpayers.
  • Businesses will be allowed to immediately expense the cost of qualified property acquired and placed in service after September 27, 2017 and before January 1, 2023 (to be phased out thereafter).
  • The net operating loss (NOL) deduction is limited to 80% of taxable income for NOLs arising in tax years beginning after 2017.
  • Section 199 domestic manufacturing deduction and certain other business tax credits will be repealed; however, the research credit will be retained.
  • The business interest expense deduction will be limited to 30% of “adjusted taxable income” (generally analogous to earnings before interest, taxes, depreciation and amortization [EBITDA] for the first 5 years and earnings before interest and taxes [EBIT] thereafter). There is uncertainty in the determination of some elements of the calculation.

International measures

  • There is no longer an interest expense limitation based on a worldwide leverage test, which was contained in earlier versions of the bill.
  • The deduction for certain related party amounts paid or accrued pursuant to a hybrid transaction or by, or to, a hybrid entity, will be denied. 
  • A base erosion and anti-abuse tax (BEAT), which essentially imposes a 10% minimum tax on a US corporation to the extent it makes significant tax deductible (or depreciable / amortizable) payments, will apply. In addition to the BEAT, additional anti-base erosion provisions are included to disincentivize the reduction of the US tax base. 
  • There will be an immediate tax on the accumulated earnings of US-owned foreign corporations (the mandatory repatriation “toll tax”) of 15.5% for earnings represented by cash or cash-equivalents and 8% for earnings represented by illiquid assets. 

For more information, see our Tax InsightsCongress gives final approval to tax reform conference committee agreement.” 

What does the tax reform legislation mean for Canadian-owned businesses?

Financial reporting impact

In light of the reduction in the corporate tax rate, Canadian-owned businesses operating in the United States should determine the financial statement impact of the new measures.

In the period in which the tax legislation is substantively enacted (under international financial reporting standards [IFRS]) or enacted (under US generally accepted accounting principles [GAAP]), companies will be required to recognize the impact of the change in tax rate on existing deferred tax assets and liabilities as a discrete item, regardless of the effective date of the change. 

For more information, see our Tax InsightsUS tax reform: Understanding the impact on financial reporting.” 

Cash flow opportunities

The reduction in the corporate tax rate also presents an opportunity to realize permanent tax savings by accelerating deductions and deferring income. For example, taxpayers may consider accelerating payment of expenses for which payment is required to crystallize the tax deduction (e.g. warranty accruals and certain compensation and benefits accruals) and accelerating purchases of qualified property eligible for full expensing. Taxpayers should review their financial and tax information to identify opportunities. 

For more information, see Your cash flow opportunities exist now, don’t wait until after tax reform.

In the short to medium term, cash tax planning should be considered. The new limitation on NOLs and the repeal of various tax credits may result in a cash tax liability, which should be considered in the context of estimated tax payment requirements (i.e. quarterly tax remittances). 

State tax implications

A diverse and wide-ranging number of state tax implications are expected to arise simply as a result of how or whether states conform to the federal Internal Revenue Code provisions as modified by the tax reform legislation. State tax consequences are expected to vary on a state-by-state basis. Thus, review and analysis of conformity provisions in material states will be important to manage compliance with state tax positions in a post-tax reform environment.

Capital structure and value chain

Despite the reduction in the corporate tax rate, Canadian-owned businesses operating in the United States might find that the stricter interest expense limitation, anti-hybrid transaction rule, and BEAT could be disadvantageous. To mitigate the adverse implications of the interest limitation and anti-hybrid transaction rule, Canadian companies should evaluate the capital structure of their US subsidiaries. 

A new anti-base erosion rule also requires current-year inclusion by US shareholders of certain global intangible low-taxed income (GILTI) of foreign subsidiaries. Another provision provides US corporations with reduced rates of US tax on certain foreign-derived intangible income (FDII). With respect to the BEAT, GILTI, and FDII, Canadian companies should evaluate whether restructuring their value chain might be beneficial.

Mandatory repatriation “toll tax”

The application of the mandatory repatriation toll tax will affect certain “sandwich” structures (where a Canadian multinational group holds certain foreign operations through a US subsidiary) and Canadian-resident US citizens who own Canadian companies. Although the toll tax is an immediate tax in respect of the undistributed accumulated earnings of the Canadian company, the tax generally may be paid to the Internal Revenue Service (IRS) over 8 years. 

While the toll tax has likely been anticipated by corporate groups with sandwich structures, the toll tax might come as a surprise to Canadian-resident US citizens who own Canadian companies.

The takeaway

The implications of HR 1 on Canadian-owned businesses can be significant. The various provisions may be beneficial or detrimental. Thus, it is important to give careful consideration to the specific implications for your operations so that value is preserved when possible.

Taxpayers should remain engaged in the tax reform process as the US Treasury Department and IRS begin the regulatory process to implement the legislation. 

 

Contact us

Debra Baker

National US Tax Leader, PwC Canada

Tel: +1 416 814 5759

Christian Fanning

Partner, PwC Canada

Tel: +1 514 205 5336

Chung Wang

Partner, PwC Canada

Tel: +1 403 509 7303

Leo Mitsiadis

Partner, PwC Canada

Tel: +1 604 806 7118

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