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USA & Canada: Opportunities in the wake of tax reform

Regulatory changes and economic uncertainty are giving North American practitioners plenty of food for thought as they navigate clients through the implications of tax reform and trade agreements. Paul Golden reports

Of the many issues exercising the minds of those in the accounting profession in the USA and Canada, the new tax code introduced with customary fanfare by Donald Trump at the end of last year is by far the most taxing.

Most practitioners reckon the most comprehensive reform to the USA tax code for 30 years is a positive development for the profession.

“Because it is disruptive, partisan and implanted without the usual comment period or ramp-up, taxpayers and businesses and their advisers are scrambling to react,” says Leslie Sobol, partner at MSI Global Alliance member firm Lucas Horsfall. “The lack of published guidance forces businesses to proceed without an understanding of the tax impact on transactions which must continue to take place while the government slowly releases explanatory regulations. The value of knowledgeable professionals has never been greater.”

Kenneth Laks, partner at BKR International member Albrecht, Viggiano, Zureck & Company and the chair of the international tax practice group for BKR International, observes that several of the reforms will require special calculations and assistance by certified public accountants who are knowledgeable about the effects of international tax. 

PKF O’Connor Davies tax partner Leo Parmegiani is even more bullish, suggesting that tax law has been stagnant for many years and tax planning considerations were drying up. “The changes have raised the accounting profession’s profile as the trusted adviser and voice of reason in a world of talking heads. It provides a platform for CPAs to have valuable conversations with our clients as to how they may be impacted.”

Jim Powers, CEO of Crowe Horwath, says practitioners will be working with clients to help them understand the impact of the changes on their overall tax strategy and how that strategy may need to be modified so that there are no surprises in the spring of 2019 when they file their first tax returns under the new law.

Reform should be looked at positively as a trigger for accounting professionals to evaluate the tax strategies they offer, says Jim Alajbegu, firm leader – international tax at Baker Tilly in New York. “Compliance with the act is an immediate need but advice and counsel is a constant. Many are curious about pursuing a C-corporation tax strategy; while others want to know what other planning opportunities exist.”

The government’s intention to simplify tax compliance has turned into a valuable service opportunity for accountants, according to William Norwalk, tax partner in charge of Morison KSi member firm Sensiba San Filippo. 

However, Scott Schoenstadt, director of tax services at fellow Morison KSi member firm Morison Cogen, describes the reforms as a double-edged sword.

“On the one hand, the new law creates opportunities for more communication and planning with clients to help them understand the impact the law has on them and their business,” he says. “On the other hand, many clients will require additional work and may not be willing to pay for the additional time.”

Sobol reckons the reforms will lead to greater collaboration between professionals in the US and their counterparts elsewhere in the world, as US entities start to unwind their existing structures and reposition their subsidiaries.

Several components of the new law will require companies with international operations to assess their structure and transfer pricing practices, explains Ed Fahey, MGI deputy chairman and managing partner at US MGI Worldwide member firm RINA Accountancy Corporation.

The US tax reform law includes provisions relating to interest deductibility, base erosion and hybrid transactions and entities, which are consistent with recommendations of the OECD’s BEPS initiative, observes Chris Kong, PwC’s US inbound tax leader.

“Taken together, these represent one of the strongest measures adopted by any country to implement BEPS actions items,” he says. “This makes it imperative that transfer pricing and international tax professionals collaborate and provide integrated and coordinated advice to US companies with international operations.” 

New withholding rules regarding the disposition of partnership interests owned by non-USA persons may decrease the appetite for USA partnerships, suggests Sobol, while lower USA corporate tax rates could make this the favoured entity choice for overseas investors seeking to take advantage of the strong domestic economy.

US-based companies have incentives to move more of their business back to the US with the reduction of the corporate tax rate to 21%, the lowering of the effective tax rate on foreign-derived income, the ability to expense fully capital expenditure and the retention of the R&D credit and the net operating loss carry forwards. 

The global intangible low tax income provision also provides a partial reason to move business back to the USA, says Kong, while also warning that these provisions need to be balanced against other tax reform provisions, such as the increased limitations on the business interest expense deduction, the repeal of the domestic production deduction and the new base erosion anti-abuse tax.

“There are numerous open questions on how these key provisions will be applied,” he adds. “Many businesses are hoping the IRS and the Treasury will provide clarification on these key issues in due course.”

The new law also has many areas that have technical errors that require correction, which leave both tax practitioners 

and taxpayers doing the best they can with what they have to apply the rules correctly, says Sensiba San Filippo partner Greg Brown.

For some clients, the impact of the various law changes on their tax liability may be easy to assess, but the implications for businesses are more difficult to determine since there are still many unanswered questions, agrees Steven Eller, partner at MSI Global Alliance member firm Gettry Marcus.

Gettry Marcus, tax attorney at Dean Surkin, says the act has a potential loophole in that a US corporation will have an advantage if it can make payments to a related foreign corporation that will be deductible in the USA and – when it is repatriated through a dividend – treated as foreign source income and thus deductible.

He notes that the act imposes a tax on accumulated foreign income at the rate of 8% on illiquid assets and 15.5% on cash and cash equivalents as of the end of 2017 and applies whether the taxpayer has patriated the income or not. “However, there is no clear evidence that the affected corporations will use the patriated cash for business expansion,” he adds.

David Springsteen, partner and practice leader national tax services at WithumSmith+Brown and chairman of the HLB International tax committee, suggests that, although many companies will evaluate migrating certain operations back into the USA in light of the lower federal corporate tax rate, state income tax and city taxes in the country will continue to make foreign operations attractive.

Changes to depreciation/expensing of business equipment and real estate create significant incentives for companies to invest in their US operations, says Fahey. “The payroll component of the 20% business income deduction, if applicable, rewards job creation. The timing will vary depending on the company’s growth plans and its need for new production capacity. The location of revenue from intellectual property will also be closely looked at by companies.”

Despite the lack of clarity around some aspects of the new law, businesses are proceeding with their plans, says Nexia International member firm Whitley Penn’s international tax partner, Brian Mitchell.

“Businesses are adapting to the changes and any uncertainty is built into their modelling exercises,” he adds. “Clients have been interested in our views and have been receptive to benchmarking within their industry in light of the new changes.”

BKR international member firms have experienced an increase in queries regarding tax reform, adds its international executive director, Maureen Schwartz, particularly questions from business owners who have companies structured as pass-through entities. Tax reform for individuals and businesses affects these owners, so they have many questions about the impact on 2017 and 2018 taxation.

Parmegiani does not believe US companies will move back en masse at this early stage, although he does anticipate more cash to return as result of the deemed repatriation toll charge tax. “Tax law is only one factor in deciding where to locate their businesses and the uprooting of assets and people and changes in global strategies take many years to implement.”

Jeffrey Mull, partner and international tax services leader at Crowe Horwath, suggests the changes are designed to send a clear message to the world that the USA is more serious about driving new business than moving businesses back there.

“Globalisation has already happened,” he adds. “However, tax reform and some of the proposed deregulation may drive other countries to make significant inbound investments and drive new business for the US. Additionally, US-based companies may now more seriously consider domestic destinations for their expansions.”

One incentive in the act that should result in US-based companies moving back some of their business is the introduction of foreign-derived intangible income rules, yielding an effective federal tax rate of 13.125% on such income earned by US C corporations, adds Alajbegu.

This incentive is of particular interest to the technology and service industries, he says. “The USA views these incentives as BEPS compliant and should allow for more intellectual property planning. Our lower corporate tax rate, in combination with our adoption of a participation exemption system, will make the US an attractive destination for global business.”

Schoenstadt notes that the 21% corporate rate only puts the US on par with the average tax rate for EU countries, though. “While the new rate is below the average for the Latin American, South American and Oceanic regions, there may not be enough of a difference to justify relocating business operations, especially after factoring in state and local taxation.”

While a lot of information will be required on structuring and how to bring back profits to the US via the new tax law, Doug Mueller, president of Allinial Global member firm Mueller Prost, expects more money to be repatriated as a result of the reforms.

In the past, middle market companies may not have been as affected by transfer pricing because of the focus on worldwide taxation, but the new quasi-territorial regime and its promise of potentially tax rates below 21% for foreign operations mean that getting transfer pricing right is more important than ever adds Robert Smith, tax manager at fellow Allinial Global member firm Saville CPAs & Advisors.

“We are seeing increased interest in using domestic corporations as holding companies for foreign investments,” he continues. “There are incentives both to move business to the US and to move more operations away from the US, so it is unclear what will be final effect will be. However, we do see that the tax reform is already having a positive effect on inbound investment in new businesses.”

On the other side of the international boundary, Chris Watson, partner at Kreston International Canadian member firm Calvista, suggests that the Canadian market has stagnated somewhat in recent years as clients increasingly view compliance-type services such as the preparation and filing of tax returns as a commodity.

“Clients are seeking business advisory services that add value, and the use of technology and the ability to respond promptly have become necessary parts of any successful relationship,” he says. “This has caused a move away from traditional reporting with an increasing emphasis on electronic communication and record keeping, which then requires greater security.”

Investors are expecting more from audits and auditors and accountants have to change their thinking to meet these higher standards, according to Brett Starkman, senior tax partner at Schwartz Levitsky Feldman and Canadian member of the HLB International tax committee.

Smaller firms are getting out of assurance work because of the onerous standards and additional risk, he says. “Fees are going up but there is a dichotomy between fees and the work that the public wants performed. Audits are becoming more sophisticated due to technology and, in certain instances, are eroding traditional services in audit and accounting.”

BKR International member firm Welch managing partner Micheal Burch agrees that the business climate for traditional accounting and audit services is in decline. “It may not show up in the numbers yet, but there is a pervasive feeling that the delivery of historical information coupled with tax compliance reporting is becoming less and less useful,” he says. “However, forward-thinking, proactive advice continues to be perceived as a high value service.”

While noting that the Canadian economy will lead growth in 2017 for the G8 economies, national managing partner RSM Canada Harry Blum refers to two major issues that could negatively affect middle-market companies this year. 

The first is the uncertainty Canadian companies face surrounding the North American Free Trade Agreement (NAFTA). “As the US takes an aggressive protectionist strategy in its NAFTA negotiations, Canadian companies could bear the brunt of the fall-out given that the US is our largest trading partner,” he explains.

Blum adds that middle market companies are also faced with ever growing complexities imposed upon them by the Canadian federal government. 

“While the US is aggressively lowering tax rates, the mindset in Canada is to target private companies and eliminate many of the incentives that reward entrepreneurs for the risks they take. Given that over 95% of the companies in Canada have fewer than 100 employees, many economists are predicting that Canada’s latest tax policy and its lack of competitiveness internationally – especially against the US – could create a recession.”

Laurence Zeifman, partner at Nexia International member firm Zeifmans in Toronto, is also concerned about the prospects for the economy now that Canada has lost its tax advantage, with the government unlikely to follow the US and lower tax rates. However, he adds: “At the same time, that could lead to increase in demand for corporate recovery and turnaround services.”

On a more positive note, Blum observes that Canada is seeing a significant jump in foreign direct investment as companies see the advantages of establishing their North American footprint in the country. Trade barriers have been significantly reduced because of the free trade agreement with the EU and the signing of the Trans-Pacific Partnership and it is anticipated a free trade agreement with China – Canada’s second largest trading partner – will follow.

Jerry Paskowitz, partner at Morison KSi member firm Sloan Partners, says 2018 is likely to be a good year for business owners to invest in productivity improvements, although he accepts that uncertainty around interest rates movements is a concern.

“In January, the Bank of Canada increased the rate from 1% to 1.25%, which was the third increase since last summer,” he explains. “In the accompanying commentary, the bank signalled further rate increases without specifying timing.”

According to Watson, the provincial nature of Canada can be unhelpful because it can pit provinces against each other in the quest for economic or political advantage. 

“This can be further compounded by the overlay of the federal government, which makes decision-making cumbersome and occasionally contradictory and definitely adds to the cost and burden of implementing major strategies,” he concludes.

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