Congress swings the BAT
The Republican-backed proposal would alter the tax system to penalize imports, without special status for Canada.
Canadian business leaders should be concerned about the new US administration in Washington, particularly the protectionist tone US President Donald Trump has adopted.
For example, a Republican-backed border adjustment tax (BAT) could severely impact Canadian exporters. It would slap a 20% tax on imports, and there would be no special status for Canada.
The plan includes lower personal tax rates that would pose a challenge for Canadian businesses seeking skilled talent, and CIBC Economics says in a February economic note that it would shift the basis of US corporate taxation from profits to cash flow, cutting the rate from 35% to 20%.
Economists Avery Shenfeld and Benjamin Tal, authors of the report, say firms would pay the 20% tax on domestic revenues after deducting purchases of domestic goods and services. Foreign operations serving markets abroad wouldn’t be taxed. Businesses would also expense capital expenditures rather than depreciating them over time. They won’t be able to claim an expense for purchases of imported goods and services, but would instead allocate those costs to their base for the 20% corporate tax.
Export revenues would be excluded from the net revenues being taxed while the 20% tax would also be applied to imports made directly by a final consumer. And no deductions for interest costs.
US advocates of the tax reform argue that rather than distorting trade, exchange rates would adjust (as in plunge) to offset the price impacts on US imports and exports. They also argue the tax on imports is fair because the same tax is embedded in the price charged by a domestic supplier that has paid tax on its net revenues. But CIBC notes domestic suppliers would get a deduction for wages. Not so for the export supplier that has already paid a corporate tax at home.
Shenfeld and Tal compare the BAT to the Smooth-Hawley Tariff of 1930 that imposed an average of 20% charge on imports. Canada, among other countries, acted quickly to impose a tariff on US exporters, which stalled global trade and helped to deepen the Great Depression.
Trump is Trump
Who knows if the BAT plan will get through Congress. Trump isn’t keen on the proposal, but he is unpredictable and protectionist. With the benefits to US companies, including those with a large reliance on domestic suppliers and a solid foreign customer base (such as producers of electrical equipment, machinery and transportation equipment), the economists say the proposal could see some light of day.
What does it mean for Canadian companies? At the micro level, the economists say export-oriented sectors such as transportation equipment, chemical, machinery and computers could feel some pain.
Roughly 20% of Canada’s GDP comes from exports to the US. But Shenfeld and Tal haven’t settled on how bad the impact would be. If the proposal does make it through Congress, a Canadian response might involve addressing corporate tax rates to entice companies not to shift operations to the US.
US law currently incentivizes multinational companies to book as much profit as possible outside the country given the higher marginal tax rates stateside. Under the proposed reform, a US company with a Canadian subsidiary would instead try to lowball the price it charged a US parent company for made-in-Canada goods or services to reduce taxes on Canadian profits. Such intra-company transfers would present an enforcement challenge for Canadian tax authorities.
Shenfeld and Tal suggest the Trump administration may seek other methods to ease corporate tax burdens. But they warn Canadian businesses to keep a sharp eye on the BAT proposal, and prepare for any sudden developments.
This article is an edited version of a CIBC Economics report, The Border Adjustment: Gauging the threat.