Canadian importers and exporters should be following U.S. tax reform developments.
Specifically, these businesses may be affected by U.S. initiatives to introduce a border adjusted tax and amend the North American Free Trade Agreement (NAFTA), as part of fundamental changes to the nature of U.S. business taxation. In their "Blueprint" for U.S. tax reform, the House Republicans consider a destination-based cash-flow tax that will have a material impact not only on Canadian multinationals and Canadian subsidiaries of U.S. multinationals, but also owner-managed businesses in Canada with cross-border sales of goods and services.
While any eventual tax legislation will likely be drafted differently than presented in the Blueprint, this document is nevertheless expected to form the basis for any anticipated tax reform (for details of the Blueprint see TaxNewsFlash-Canada 2017-02, "U.S. Primed for Tax Reform Changes [PDF 72 KB]"). Some of these changes could be introduced in upcoming U.S. budgets (for details on the U.S. budget process see Global Tax Adviser "Will U.S. Budget Herald Tax Reform?", dated January 27, 2017), but it is unknown whether the United States will pass a tax reform bill in 2017 due to expected debate over the merits of the proposals in the Senate. Already the new administration has pushed its expected timeframe for tax reform to 200 days (from 100 days), and some say that 2018 appears to be a more realistic timeframe.
Border Adjusted Tax
In broad terms, the BAT proposes to make imports of products, services and intangibles taxable and exports of those items exempt from corporate taxation. Consequently, the proposal is controversial, with both proponents (most notably, U.S. manufacturers with domestic supply chains and substantial exports) and opponents (importers, but also certain retailers, oil refiners and U.S. manufacturers with global supply chains). If the Blueprint is enacted, affected companies would have to re-evaluate their supply and distribution chains.
Advocates of the BAT argue that its impact on affected taxpayers should be relatively neutral, since it should lead to a rise in the value of the U.S. dollar, making imports proportionately cheaper and exports proportionately more expensive. While certain economist will argue that a perfect currency adjustment should result in no net impact on the U.S. balance of trade (with the BAT ultimately borne by foreigners transacting in U.S. dollars), this is probably unlikely. For example, a U.S. trading partner's response to the BAT (such as putting in place retaliatory tariffs) may have an opposite effect on the relevant exchange rate. Additionally, the Blueprint's other proposals would also affect the value of the US dollar. It remains to be seen whether lower taxes and other potential tax and economic benefits will outweigh any adverse consequences of the BAT.
In addition to other concerns, it is unclear whether the BAT violates current U.S. tax treaties and trade agreements. For example, the World Trade Organization (WTO) may reject the BAT as being incompatible with its rules. Specifically, under WTO rules, imports generally must be treated in the same manner as domestically-produced goods and services. The BAT, which proposes to tax the entire value of imported goods, does not appear to meet these rules. These considerations, together with other potential actions of the Trump administration, are creating uncertainty regarding international trade with the United States.
President Trump has already signed an Executive Order to effectively withdraw the United States from the Trans Pacific Partnership (TPP). In addition, the President has stated that he intends to take steps to renegotiate the North American Free Trade Agreement (NAFTA), or potentially withdraw from the agreement unless terms favourable to the U.S. can be reached. President Trump's position on NAFTA is in contrast to the position of many U.S. business lobbyists and political leaders, who are strongly opposed to withdrawing from NAFTA. The primary focus of the renegotiation appears to be on Mexico.
If President Trump is able to persuade Congress and the Senate to renegotiate NAFTA, the U.S. must provide six months' notice under the provisions of the agreement, and several months of negotiations would likely be required. As such, it is expected that any changes may take some time to implement.
Renegotiating or withdrawing from NAFTA could have significantly adverse consequences for U.S. exporters. Canada is currently one of the United States' largest trading partners, and its largest customer for exports. Additionally, although Canada generally has a trade surplus with the U.S. on goods (approximately US$15 billion in 2015), it generally has a much larger trade deficit on services (approximately US$27 billion in 2015). As such, if Canada were to retaliate, or if tariffs reverted to most-favoured-nation rates, U.S. exporters could be negatively affected.
A further consideration is that two-thirds of goods that cross the border are semi-processed goods used to make other goods. In the automotive sector, for example, parts and sub-assemblies may cross the border as many as six or seven times before a vehicle is ultimately exported. Duties on imports of parts and materials into the United States will increase U.S. production costs in these circumstances.
If the United States withdraws from NAFTA altogether, the original free trade agreement (FTA) between Canada and the U.S. is still in effect. However, NAFTA was a significant improvement over the FTA and another legislative process would likely be required to modernize the FTA. NAFTA would, however, remain in effect between Mexico and Canada.
Until the fate of NAFTA is known, Canadian companies with U.S. subsidiaries or that simply do business in the US will face considerable uncertainty regarding their cross-border trade.
For more information, contact your KPMG adviser.
Information is current to February 09, 2017. The information contained in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's National Tax Centre at 416.777.8500