Why the US Inflation Reduction Act poses a major fiscal challenge for Finance Minister Chrystia Freeland

Finance Minister Chrystia Freeland speaks to reporters ahead of Question Period in the House of Commons on Parliament Hill in Ottawa on June 23.Justin Tang/The Canadian Press

When the US Senate passed the Cut Inflation Act earlier this week, Canadian political and industry leaders were thrilled by the legislation’s climate provisions, which look likely to give industry a boost. electric vehicles in the country. But other major changes in the bill have 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 increased the minimum US corporate tax rate to 15%. This would likely have brought the United States into compliance with a key part of a global tax agreement announced last summer by Canada and more than 130 countries of the Organization for Economic Co-operation and Development, the intention of which was to to prevent multinational companies from evading their tax obligations. .

But the minimum corporate tax provision was recently dropped in a major behind-the-scenes review 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 United States, 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 repeated an earlier warning: if the OECD deal is not implemented, Canada will introduce its own 3% tax on the digital revenues of large multinationals. The move could expose U.S. 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, would come into effect on January 1, 2024 and apply retroactively to cover revenue generated on or after January 1, 2022.

Ms Freeland, who is also deputy prime minister, praised the OECD tax deal when it was announced last summer.

The OECD said at the time that the deal, if finalized, would bring more than US$150 billion a year to governments around the world by cracking down on corporate use of tax havens and creating a creative accounting to pay less tax.

The plan proposed two main approaches: countries around the world would change their tax obligations to focus on the location of sales rather than a company’s head office, and they would agree to an overall minimum tax rate of 15% .

Ms. Freeland’s 2022 federal budget specifically mentioned that proposed US legislation would implement the minimum corporate tax rate of 15%.

But as US politics focus on November’s midterm elections and polls showing control of the House of Representatives could shift from Democrats to Republicans, some tax watchers say the window for the US Congress to to adopt the OECD agreement has now arrived. and gone.

In addition to its reversal on the 15% minimum, the US Congress has made no move to implement the OECD agreement’s approach to place of sales.

When asked this week to respond to U.S. developments, Adrienne Vaupshas, ​​spokeswoman for the finance minister, said in a statement to The Globe and Mail that Canada was closely monitoring international events related to the implementation implementation of the OECD agreement and that the government was ready to act on its own.

“Canada’s priority and preference has always been a multilateral agreement, however, to ensure the interests of Canadians are protected, we intend to move forward with legislation finalizing the enactment of a tax on digital services,” she said. “We sincerely hope that the rapid implementation of the new international system will make this DST unnecessary.”

Scheduled daylight saving time was first announced in 2020 and detailed in the Fall 2021 Economic Update.

Last month, US Trade Representative Katherine Tai issued a statement reiterating Washington’s deep concern over Canada’s plans. The United States has hinted that it will retaliate against Canada if it adopts a DST. The United States has also challenged DST plans in other countries, arguing that OECD discussions should precede any new tax measures on multinationals.

Elliot Hughes, a senior adviser at Summa Strategies, who previously worked as a tax policy adviser to Ms Freeland’s predecessor as finance minister, Bill Morneau, said it appears the US Congress will not approve the tax plan of the OECD, which would pave the way for a major political dispute between Canada and the United States

“I think Freeland will have to move forward,” he said of the digital services tax. “And that’s going to be a big, big deal and lead to potentially quite serious trade issues between the two countries.”

Much of the attention on the US Inflation Reduction Act in Canada has focused on the fact that Canadian lobbying efforts have succeeded in securing a change that will ensure that US incentives for vehicle manufacturing will apply to vehicles manufactured anywhere in North America. The original wording of the bill would have applied the incentives only to vehicles made in the United States.

Ms. Freeland held a news conference Tuesday in Etobicoke at an auto parts plant, largely to celebrate Canada’s avoidance of a major trade dispute.

The Reducing Inflation Act includes a new provision for a 15% alternative minimum tax on large corporations. The US government estimates the measure will generate $300 billion in new revenue over the next decade, but the tax is country-focused and differs significantly from the proposed global minimum corporate tax of 15%. The United States recognizes that it would not be in compliance with the OECD agreement.

US Treasury Secretary Janet Yellen, who had championed the OECD deal as a global effort to curb the race to the bottom on corporate taxation, said in statements to media from his office that the global minimum tax remained a top priority.

The OECD remains committed to the agreement. He announced last month that the deadline for signing had been extended to mid-2023, with implementation due to take effect in 2024, a year later than planned.

Ms. Freeland’s April 2022 budget launched consultations on how Canada could implement the global minimum corporate tax rate. Consultations ended on July 7 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 included a directive that no corporate directors and officers should live in Canada and all books and records should be kept in the United States.

A Canadian DST would aim to counter these legal tax avoidance tactics, which are often used by foreign multinationals with a large customer base in Canada.

Wei Cui, a professor of law and tax policy at the University of British Columbia, said there have been significant misunderstandings related to the various tax proposals.

He said the latest U.S. tax plan includes some international elements that strengthen taxation of U.S. multinationals beyond existing legislation. He noted that Washington had already taken a leadership position with a 2017 policy known as Global Intangible Low-Taxed Income, or GILTI, which changed the US government’s treatment of foreign-source income earned by corporations. under American control.

The Inflation Reduction Act’s predecessor, the Build Back Better Act, would have raised GILTI’s effective tax rate from 10.5% to 15%, which is why some observers have said the original bill would have allowed in the United States to comply with the global policy of the OECD. minimum tax.

Although this proposed tax change was removed as part of the revised Inflation Reduction Act, Professor Cui noted that the new legislation still increases taxes on the foreign income of many large U.S. multinationals.

Just as the United States is taking its own approach to taxing multinationals, Professor Cui said, so can Canada. He argued that statements by political leaders suggesting that all countries must act in unison are problematic.

“It’s a kind of political rhetoric that has always been detached from reality,” he said.

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