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R.I.P. border adjustment tax: Canadian implications

Author(s): Julie Geng, Jennifer Lee, Paul Seraganian

July 28, 2017

Yesterday afternoon, the so-called “Big 6” (comprised of key Republican leaders from the White House and Congress) released a short and fairly vague mission statement for their “shared vision” for U.S. tax reform. While it is only five paragraphs long, the Joint Statement on Tax Reform (the Joint Statement) delivered major relief to Canadian businesses – it confirmed that the hotly contested border adjustment tax (BAT) will not be included in U.S. tax reform.

The BAT (summarized in our prior update) would have effectively imposed U.S. tax on imports into the United States while exempting U.S. exports. U.S. industries dependent on foreign imports, such as retailers and refiners, were staunchly opposed to the BAT. They argued that it would cause a debilitating increase in costs of foreign products, unfairly prejudice their business and result in increased costs for ordinary Americans. While there were competing hypotheses on whether currency adjustments and other macroeconomic forces would neutralize this adverse economic impact, skepticism (and strong lobbying) prevailed. The Joint Statement conceded that, “[w]hile we have debated the pro-growth benefits of border adjustability, we appreciate that there are many unknowns associated with it and have decided to set this policy aside in order to advance tax reform.”

It is difficult to overstate the significance of this development for Canadian businesses. According to the U.S. Department of Commerce, close to 20% of Canada’s GDP in 2015 was attributable to exports to the U.S. Only Mexico and Vietnam have greater portions of their economies tied to U.S. exports.  While there is still rampant uncertainty about the shape that U.S. tax reform will take, the knowledge that this reform process will proceed without the BAT is a significant step forward for Canadian businesses. 

Other highlights of the Joint Statement include:

  • Lower rates: The statement pledges commitment to “a lower tax rate for small businesses so they can compete with larger ones, and lower rates for all American business so they can compete with foreign ones.” It offers no concrete details on what these rates will be.
  • Expensing: The statement announces the goal of “unprecedented capital expensing”.  This language falls short of endorsing the “full expensing” of capital expenditures contemplated in the House blueprint, a sign that there is still no consensus on the question of whether interest deductibility should be eliminated to allow for full capital expensing.
  • Permanence: The statement indicates that the tax reform effort will place “a priority on permanence”. This suggests that there will be an effort to achieve deficit neutrality over the 10-year budget window, which, in turn, implies that Congress will need to generate material (and as yet unidentified) revenue raisers and/or sharply decrease spending. This will no doubt prove to be a challenging feat.
  • Territoriality: While many expect that tax reform would move the U.S. to a “territorial” system of taxation, similar to Canada’s, the statement interestingly falls short of embracing this. This may indicate that there is a lack of consensus about what a U.S. territorial approach would look like. 
  • Consumption tax: The statement confirms that tax reform will not include “a new domestic consumption-based tax system,” which appears to be a definitive shift not only away from BAT but also consumption taxes generally, such as a federal value added tax (VAT). Currently, U.S. states impose sales and use taxes and other consumption-based taxes, and VAT on a national scale had always been a part of the discussion on potential reform.
  • Time frame: The statement articulates the “expectation” that tax reform legislation will move through the House and Senate tax writing committees in the fall and be voted on in Congress after that. The statement does not commit to completion in 2017 which, in light of all the surrounding circumstances, seems wise.