Finance Minister Chrystia Freeland speaks to reporters before heading to question period in the House of Commons on Parliament Hill in Ottawa on June 23. Justin Tang/The Canadian Press
When the United States Senate passed the Inflation Reduction Act earlier this week, Canadian political and industry leaders were buoyed by the climate legislation’s provisions, which look likely to provide a boost to the country’s electric vehicle industry. But other major changes in the bill set the stage for a trade standoff between the two countries over digital sales taxes.
An earlier version of the US bill would have effectively raised America’s top corporate tax rate to 15 percent. That would likely bring the U.S. into line with a key element of a global tax deal announced last summer by Canada and more than 130 countries of the Organization for Economic Co-operation and Development, which aimed to prevent multinational companies from avoiding tax obligations.
But the minimum corporate tax provision was recently removed as part of a major behind-the-scenes overhaul of US law, and the updated bill is expected to receive final approval in the coming days. The reversal means the OECD tax deal may have to go ahead without the full participation of the US, the world’s largest economy, which would significantly weaken the deal.
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With the deal under pressure, Finance Minister Chrystia Freeland’s office this week reiterated an earlier warning: If the OECD agreement is not implemented, Canada will introduce its own 3 percent tax on the digital revenues of large multinationals. The move could expose US corporations to billions of dollars in new tax liabilities and complicate economic relations between Canada and its largest trading partner.
The Digital Services Tax, or DST, will come into force on January 1, 2024 and will apply retroactively to cover revenue earned from January 1, 2022.
Ms Freeland, who is also deputy prime minister, praised the OECD tax deal when it was announced last summer.
At the time, the OECD said the deal, if finalized, would raise more than $150 billion a year for governments around the world by cracking down on corporations’ use of tax havens and creative accounting to pay less tax.
The plan proposes two main approaches: countries around the world would shift their tax obligations to emphasize the location of sales rather than the location of a company’s headquarters, and agree to a global minimum corporate tax rate of 15 percent.
Ms. Freeland’s 2022 federal budget specifically mentions the fact that the proposed US legislation plans to introduce the 15 percent corporate tax floor.
But with the focus of U.S. politics shifting to November’s midterm elections and polls suggesting control of the House of Representatives could shift from Democrats to Republicans, some tax watchers say the window for the U.S. Congress to pass the OECD deal is now has come and gone.
In addition to repealing the 15 percent minimum, the US Congress has not taken any steps to implement the OECD transaction approach to the location of sales.
When asked this week to respond to developments in the U.S., Adrien Woupshas, a spokesman for the finance minister, said in a statement to The Globe and Mail that Canada is closely monitoring international developments related to the implementation of the OECD deal and that the government is prepared to act independently.
“Canada’s priority and preference has always been a multilateral agreement, but to ensure that the interests of Canadians are protected, we intend to move forward with legislation finalizing the introduction of a digital services tax,” she said. “We sincerely hope that the timely implementation of the new international system will make this daylight saving time unnecessary.”
Planned DST was first announced in 2020 and further described in the Fall 2021 Economic Update.
Last month, U.S. Trade Representative Catherine Tye issued a statement reiterating Washington’s strong concerns about Canada’s plans. The US has hinted at retaliation against Canada if it adopts daylight saving time. The US has also challenged DST plans in other countries, arguing that OECD discussions should precede any new tax action against multinationals.
Elliott Hughes, a senior adviser at Summa Strategies who previously worked as a tax policy adviser to Ms. Freeland’s predecessor as Treasury Secretary, Bill Morneau, said it appeared the US Congress would not approve the OECD’s tax plan, which would set the stage for a significant political dispute between Canada and the US
“I think Freeland is going to have to go ahead with it,” he said of the digital services tax. “And that’s going to be a big, big problem and it’s going to lead to some potentially pretty serious trade problems between the two countries.”
Attention to the U.S. deflation law in Canada has largely focused on the fact that Canadian lobbying efforts successfully secured a change that would make U.S. incentives for electric vehicle production apply to vehicles manufactured anywhere in North America. The original wording of the bill would have applied the incentives only to US-made vehicles.
Ms. Freeland held a news conference Tuesday in Etobicoke at an auto parts manufacturing plant, largely to celebrate the fact that Canada has avoided a major trade dispute.
The Inflation Reduction Act includes a new provision for a 15 percent alternative minimum tax on large corporations. The US government estimates the measure would raise $300 billion in new revenue over the next decade, but the tax is aimed at the domestic market and is substantially different from the proposed global minimum corporate tax of 15 percent. The US admits this would not be consistent with the OECD deal.
US Treasury Secretary Janet Yellen, who has championed the OECD deal as a global effort to stop the race to the bottom in corporate taxation, said in statements to the media from her office that the global minimum tax remains a top priority.
The OECD remains committed to the deal. He announced last month that the deadline for signing had been extended to mid-2023, with implementation taking effect in 2024, a year later than originally planned.
Ms. Freeland’s April 2022 budget launched a consultation on how Canada can implement the global minimum corporate tax rate. The consultation closed on 7 July and the government has not released any further information on the status of this plan.
A recent Globe and Mail analysis detailed Amazon’s extensive efforts to limit its executive presence in Canada in order to legally reduce its Canadian tax liability. This includes a directive that directors and officers of companies must not live in Canada and all books and records must be kept in the US
Canada’s DST would aim to counter such legal tax avoidance tactics that are often used by foreign multinationals with large client bases in Canada.
Wei Cui, a professor of tax law and policy at the University of British Columbia, said there have been significant misunderstandings surrounding the various tax proposals.
He said the latest US tax plan does include some international elements that strengthen the taxation of US multinationals beyond existing law. He noted that Washington had already taken the lead with a 2017 policy known as Global Intangible Low Tax Income, or GILTI, which changed the US government’s treatment of foreign-sourced income earned by US-controlled companies.
The Inflation Act’s predecessor, the Build Back Better Act, would have raised the effective GILTI tax rate from 10.5 percent to 15 percent, which is why some observers said the original bill would have allowed the U.S. to catch up with global demands OECD minimum tax.
Although the proposed tax change was removed as part of the revised Inflation Reduction Act, Prof. Cui noted that the new legislation still increases taxes on the foreign income of many large US multinationals.
Just as the US is adopting its own approach to taxing multinationals, Prof Cui said, so can Canada. He argues that statements by political leaders suggesting that all countries must act in unison are problematic.
“This is the kind of political rhetoric that has always been disconnected from reality,” he said.
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