You can thank provincial taxes for Canada’s higher overall tax rate
The role of provincial tax rates is frequently lost in the brouhaha over the negative impact that U.S. tax reform will have on the Canadian economy.
“The difference in U.S. and Canadian corporate tax rates is caused by provincial tax rates that are much higher than state corporate taxes,” says Barry Horne of Halifax, a corporate and tax lawyer who is co-chair of McInnes Cooper’s cross-border group. “It’s true that Canada’s corporate tax rate is nominally 25 per cent, but there is a 10 per cent federal abatement that allows the province to impose their own taxes.”
Comparing the nominal federal rate of 25 per cent with the U.S. rate of 21 per cent, then, is misleading. Head-to-head, Canada’s true federal rate of 15 per cent maintains a six per cent advantage over its U.S. comparable.
And to its credit, the federal government has been proactive in this arena.
“Over the past 10 years, the federal tax rate has declined four per cent to 15 per cent, but the vast majority of provinces have not reduced their provincial corporate tax rate at all during this time,” says Brad Coutts, a financial planner at Nicola Wealth Management in Toronto. “The only province with meaningful reductions in the general corporate tax rate is Ontario.”
The fact that Canada still has overall rates higher than those in the U.S., then, lies squarely at the feet of the provincial governments.
Nova Scotia and Prince Edward Island, at 16 per cent, have the highest rates. British Columbia (11), Ontario (11.5) and Quebec (11.8) have the lowest.
Only one U.S. jurisdiction, Iowa, at 12 per cent, has a tax rate higher than the lowest provincial rates. Most states’ rates are below 10 per cent. Nevada, Ohio, South Dakota, Texas, Washington and Wyoming don’t have a corporate income tax at all.
“So B.C., which used to have the lowest combined corporate tax rates in North America, now has the 24th-highest rate,” Horne says. “Nova Scotia and P.E.I. have the very highest.”
To be sure, tax rates are but one consideration in determining the overall effective corporate rate.
“It’s important to determine how income is calculated in each jurisdiction,” Horne says. “But having said that, the new accelerated depreciation rules under tax reform give the U.S. an important advantage.”
“The new rules allow American businesses to immediately expense tangible property that has a life of 20 years or less,” Coutts says. “Canada’s capital cost allowance system in general allows corporations to deduct only a small portion of their asset purchases annually, and the way the declining balance rules are structured, Canadian companies may frequently never get to fully deduct the entire cost.”
Further complicating a comparative assessment of U.S. tax reform is the fact that four states tax gross receipts rather than income and six states have higher graduated rates.
“Taxing gross receipts is generally thought to be very punitive because companies could be forced to pay large amounts of tax even when they are not profitable,”Coutts says. “Higher graduated corporate tax rates are thought to be ineffective because they just encourage tax planning that will allow them to split up the company and find ways to lower their taxable income to avoid the higher corporate tax rate.”
And while the U.S. does not have a small business tax rate for the first $500,000 of taxable income, as Canada does, the tax system does allow small businesses to structure as “flow-thru entities,” which may result in them paying no corporate tax at all.
“Flow-thru entities can in some circumstances be even better than the special rate for small business because the income can flow directly to the owner, who may then be taxed at lower marginal rates,” Coutts says.
American small business owners who are married with children can income split by filing as couples. In Canada, where the federal government introduced punitive taxes in 2018 on “income splitting dividends” paid to spouses who play no active part in the business, income splitting is much more difficult for small business owners.
All this having been said, the fact remains that most of Canada’s provinces have so far shown little initiative or foresight in dealing with the competitive threats arising from tax reform in the U.S.
“The provinces should be doing more to lower Canada’s corporate tax rate and increase our competitiveness,” Coutts says. “It is important to remember that people, corporations and capital are all more mobile than ever before and they will go wherever they think it is best for them.”