President Trump signed House of Representatives bill 1 (originally referred to as the “Tax Cuts and Jobs Act”) (the Act) into law on December 22, 2017, ushering in the most significant changes to the US tax Code since 1986. These changes substantially modify the US tax Code and will significantly impact US domestic and international taxation. The impact of the changes in the Act cannot be understated: the massive bill includes $5.5 trillion in tax cuts offset by $4.0 trillion in tax increases, measured over 10 years. Certain changes, such as the reduction of the corporate income tax rate, will impact almost every BC business with US activities. Other very specific provisions, such as favourable expensing of damaged citrus trees, will have a more limited effect. There will be winners and losers. Every BC business with US activities or US competitors should understand, assess, and plan for the impact of the Act.
Setting the stage
President Trump’s election set the stage for Congressional Republicans to enact long-awaited tax reform. Failed attempts at repealing the Affordable Care Act (colloquially known as “Obamacare”) and overhauling immigration policy earlier in 2017 fueled a strong political incentive for a Republican “win” during President Trump’s first year (and before Congressional midterm elections in 2018).
Tax practitioners and the business community were surprised at how quickly the Act was passed. In a seven-week period, starting with the House’s draft tax bill on November 2, 2017 and ending with President Trump signing the Act on December 22, 2017, Congressional Republicans narrowly passed an entirely partisan tax bill. The hurried passing of the Act may be famously remembered for handwritten amendments and late-night Congressional votes.
The speed at which the Act was pushed through Congress has led to drafting errors and ambiguities that are certain to cause angst for tax practitioners and businesses for years. Necessary technical corrections and Internal Revenue Service regulatory interpretations are expected in the coming months (and years) with subsequent courtroom battles to follow.
Pervasive economic impact
The changes in the Act, which are intended to grow the US economy and bring jobs to the US, are making waves throughout international tax and business communities. A lower corporate tax rate, favourable capital asset expensing provisions, and a one-time mandatory repatriation of certain offshore profits, are designed to boost US investment and economic growth. New international provisions promote an “America-first” policy by incentivizing businesses to operate in the US and punitively taxing certain large multinational companies making deductible payments to non-US affiliates or earning more than a 10% return on tangible business assets in low tax countries. Even businesses that are not subject to US tax will be impacted by the Act - the new law is already influencing the allocation and investment of capital. For example, Apple was quick to announce capital expenditures in the US of $30 billion of over five years (paid for with newly repatriated overseas profits).
In many cases, the new US federal tax rate, plus state tax rate, will be comparable to BC’s combined 27% federal and provincial tax rate. Therefore, tax rates will not necessarily be a significant driver of where a business chooses to locate or invest. Other factors, such as the ease of doing business and labour market competiveness, will become increasingly important.
Canada’s lack of response to the Act amplifies uncertainty for BC businesses. The recently released Canadian federal budget did not contain any significant provisions intended to increase Canada’s tax competiveness relative to the US. Canada may react with a more comprehensive approach as it considers the overall impact of the US tax reform on Canada’s economy. On a more positive note, historical trends predict that Canada may see a temporary economic boost due to “spillover” US economic growth.
Overview of changes impacting BC businesses
Originally lauded as a simplification of the US’s “broken” tax Code, the Act leaves most of the existing corporate provisions largely intact. The Act modifies existing rules and adds layers of complex international provisions.
Key General Provisions Impacting BC Businesses
|Corporate tax rate reduction
||The Act adopts a flat 21% corporate tax rate (compared to a top marginal rate of 35% pre-tax reform).
||Generally January 1, 2018 (special rules for fiscal year-end taxpayers).
|Net operating loss (NOL) limitations
||The Act eliminates NOL carrybacks and limits NOL carryovers to 80% of taxable income with no expiration. Previously, NOLs could be carried back two years and carried forward up to 20 years.
||The new rules apply to NOLs arising in tax years beginning after 2017.
|Capital property expensing
||The Act provides an immediate 100% deduction of the cost of qualifying tangible property purchased and placed in service in the US after September 27, 2017 and before 2023. The deduction will phase-down over four years, beginning in 2023.
||Qualifying property purchased and placed in service after September 27, 2017.
|Interest expense limitation
The Act generally limits the deduction of net business interest expense (including interest on third-party debt) that exceeds 30% of the business’s adjusted taxable income (ATI). ATI is essentially tax earnings before interest, taxes, depreciation and amortization for tax years beginning after 2017 and before 2022, and tax earnings before interest and taxes for tax years beginning after 2022.
Denied interest deductions are carried forward indefinitely. Certain small businesses and certain electing real estate businesses generally are exempt from the new interest limitation rules.
|Tax years beginning after 2017.
|Deduction limitations for hybrid transactions
||The Act denies a deduction for payments of interest and royalties involving certain hybrid transactions and hybrid entities. This provision could impact certain financing and other structures commonly used by Canadian-based businesses.
||Tax years beginning after 2017.
International tax provisions
The Act leaves many of the pre-tax reform international provisions largely intact and layers on a complex system of new provisions that generally:
- Shift the US from a system of worldwide taxation to a partial territorial system, with a one-time tax on previously unrepatriated profits of non-US corporations levied on certain US shareholders.
- Promote an “America first” policy through various carrot and stick provisions intended to encourage businesses to shift operations to the US and discourage certain payments to non-US related parties.
In addition to the provisions discussed above, there are many other factors associated with the Act that will impact BC businesses. KPMG’s recently released reports, Canadian Multinationals – Prepare for U.S. Tax Changes and New Tax Law, offers detailed insight into business tax, individual tax, and other new provisions arising from the Act.
State tax considerations
With the US federal rate now reduced to 21%, state income tax has become relatively more important. States’ reactions to the Act are still evolving. Individual states are free to write their own tax legislation, resulting in a jumble of differing state tax rules. Most states use federal taxable income as a starting point for calculating state taxable income, but the mechanism for doing so varies. Many states, including California and Oregon, will have to take legislative action to adopt the new law. Where states are slow to adopt the changes in the Act, taxpayers will have to compute taxable income under different versions of the US tax Code, adding significant incremental compliance burdens.
BC businesses should follow developments in states where they have significant tax exposure. The passing of the Act may result in changes to state tax codes, additional state tax, and additional compliance considerations.
Action plan for BC businesses
Understand the Act
BC businesses should consult their tax advisor to understand both the current and future effects of the Act. Each individual provision should be assessed to determine the net impact on the business. Further, BC businesses should monitor provisions with phase-up or phase-down effects or exemption thresholds to help assess their future impact.
Assess and react
Businesses with financial reporting obligations, especially public companies with external reporting deadlines, should immediately consider the impact of tax reform on their tax provisions. Deferred tax assets and liabilities may need to be revalued and taxable income forecasts adjusted.
Businesses should also determine the impact of the Act on cash flow projections, valuation models, and any tax-affected forecasts. The Act may impact decisions such as where to develop and locate intellectual property, when and where to make capital investments, and even how to legally structure operations.
Further, businesses should assess and adjust their investment plans, internal structures, and current activities to take advantage of favourable provisions in the Act (e.g., the full capital asset expensing provisions) and to avoid unfavourable provisions in the Act (e.g., the hybrid limitations and business interest expense limitation).
Businesses may even consider moving functions, operations, and people in light of the new law, with transfer pricing policies being adjusted accordingly.
And, of course, affected business will need to make changes to calculations of taxable income for purposes of 2018 tax year installments and, for many taxpayers, changes to their 2017 tax returns.
Law, especially tax law, is always subject to change. A change in government, perhaps as a result of upcoming Congressional midterm elections, could result in amendments to the Act. However, both the Republicans and Democrats have long acknowledged that the US tax Code was in dire need of an overhaul to make the US tax system competitive with other developed countries. Amendments, if any, are unlikely to include a complete repeal of the Act.
In any event, the Act is the tax law currently in effect and has introduced sweeping changes to the US tax Code. Affected BC businesses should take action as soon as possible to understand, assess, and react to the new law to ensure compliance and to remain competitive.
Jodi M. Moss, CPA, CA is a partner in KPMG’s US corporate tax practice in Vancouver, BC. Mick Stobart, CPA, CA is a senior manager in KPMG’s US corporate tax practice in Vancouver, BC.