Obama, Multinationals, and Canada

Multinationals like Apple, Google, and General Electric have accumulated mountains of untaxed profits overseas, a fact that has angered many. But contrary to popular belief, this is not the case for every multinational. It is strictly an American phenomenon.

This kind of situation is not found in either Europe or Canada. It is because the United States has an archaic financial system, one that Barack Obama wants to reform.

How does it work? And how is it different from ours?

In the United States, profits earned overseas by American corporations’ subsidiaries are subject to heavy taxes once they are repatriated. As long as the money stays overseas it is not taxed. But once it returns, a 35 percent federal tax and sometimes an additional state tax is levied.

These high rates have had consequences on the American economy. They have prevented gigantic sums of money from being repatriated—there could be up to $2.1 trillion in U.S. dollars held outside the United States, according to some estimates. That is equal to Canada’s entire gross domestic product.

Tax authorities in most other industrialized countries do not operate like the Internal Revenue Service. Funds that are repatriated from overseas are often exempt from taxation, as is the case here in Canada, as long as there is a tax agreement with the host country.

There is a simple reason for this tax exemption. It is to prevent our companies from paying taxes twice: once in the host country, and again in Canada. There have been abuses of course, but it is the guiding principle behind our system.

European Union countries have a similar system. For example, a French multinational will not pay taxes on profits repatriated from Germany because it already paid taxes in Germany and vice versa.

Barack Obama wants to change this American exception. He is proposing that as of 2016, American companies will pay a minimum tax of 19 percent on their current profits gained overseas. However, the reform contains a mechanism that would reduce that rate according to the amount of taxes paid abroad.

In other words, if Apple has already paid 12.5 percent on its profits in Ireland, it would essentially only pay 6.5 percent to the IRS. If the foreign tax rate is 25 percent, it would pay nothing in the United States.

This 19 percent minimum rate system would therefore not penalize American companies that pay their fair share of taxes elsewhere and would no longer dissuade companies from repatriating funds. But it would punish multinationals that only pay a small amount to tax authorities overseas for their ongoing operations.

Barack Obama is not stopping there. On past profits, that is, the accumulated $2.1 trillion in U.S. dollars, he wants to collect a one-time 14 percent tax, which would bring in $268 billion in U.S. dollars—almost as much as Quebec’s annual GDP. The money would be used to pay for infrastructure work and to reduce the deficit.

In exchange, the U.S. president would offer companies a gift. He would reduce their federal tax rate from 35 percent to 28 percent (in Quebec, the combined federal-provincial rate is 26.9 percent). The reform would increase the federal individual tax rate on capital gains from 20 percent to 28 percent.

“The United States has an archaic system. In a way, Obama is now proposing to harmonize it with those of other countries. The objective is to make the American tax system more competitive,” explained PricewaterhouseCoopers tax adviser Éric Labelle.*

Obama’s reforms will probably not be adopted as-is since Democrats do not have a majority. But Republicans have shown openness to the idea as long as the system is simplified. For example, during negotiations, the 14 percent rate on profits gained overseas could be reduced to 10 percent and the corporate tax rate dropped below the planned 28 percent.

In any event, these changes could inspire Canada. Here, repatriated funds are exempt from taxes even if the money comes from a country that has low or no taxes like Barbados, a country with which we have a tax agreement. A rate similar to Obama’s 19 percent minimum would be fair.

However, the Harper government has not chosen this option yet. For the past five years, Canada has signed tax agreements with several other tax havens (the Bahamas, Isle of Man, British Virgin Islands, etc.). On one hand, these agreements allow Canada to lift the tax secrecy of Canadian companies that do business in these countries, but on the other hand, these companies can now repatriate funds to Canada without having to pay taxes (as long as they have significant operations there).

A story to follow considering the upcoming federal elections…

Author’s Note: PROFITS GAINED OVERSEAS: SOME EXAMPLES (in billions, U.S. dollars)

General Electric $110 billion

Microsoft $76 billion

Pfizer $69 billion

Apple $54 billion

IBM $52 billion

Sources: Les Affaires and The Wall Street Journal

*Editor’s Note: This quote, although accurately translated, could not be verified.