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For U.S. doctors, lawyers, and accountants, setting up a professional corporation in Canada has until now been a tax-favorable way to save additional money for retirement.
But now those individuals will be the unexpected recipients of a hefty tax bill stemming from the U.S. 2017 tax act (Pub. L. No. 115-97), barring a “Hail Mary” reprieve. The new law sets up U.S. or dual citizens with assets housed in Canada to be taxed twice: a U.S. tax on the profits themselves and a Canadian tax on the future distribution of the funds.
On top of the double taxation scenario, most individuals won’t be able to claim a tax credit to offset the U.S. tax bill. And options for Canada to alleviate the tax hit, like creating a tax credit or convincing the U.S. government to change course, are full of pitfalls, practitioners told Bloomberg Tax.
It poses a problem for Roy Berg, who is a dual citizen and has a professional corporation in Canada. He is also the director of U.S. tax law at Calgary-based Moodys Gartner Tax Law LLP.
“I’m getting kicked in the teeth on this,” he said.
Tax reform created a one-time, two-tiered tax on foreign earnings: 15.5 percent for cash and 8 percent for illiquid assets. The levy was aimed at giant corporations like Microsoft Corp. and Pfizer Inc., which the U.S. wants to keep from stashing billions of dollars offshore. But it will also hit Canadian residents with U.S. citizenship who declare the assets on their 2017 tax returns, generating bills on earnings potentially stretching back years.
“They gave no time for any kind of planning,” Veronika Chang, a lawyer with Morris Kepes Winters LLP in Toronto, said Aug. 15.
Any possible reprieves are riddled with challenges, practitioners said.
Taxpayers who decided to argue against the tax could lean on the bilateral treaty between the U.S. and Canada. That move is a “dog of an argument,” as the U.S. often passes laws that override it, Berg said.
The treaty aims to minimize double taxation and the U.S. Supreme Court has ruled that overriding the treaty must be explicit, but U.S. tax law and regulations are silent on the treaty, said Max Reed, a lawyer at SKL Tax in Vancouver.
“Although we think this position is legally correct, it is obviously not without risk,” Reed said. Using a treaty to override Internal Revenue Service regulations, “even where the law is somewhat clear, is not for the faint of heart,” he said.
Or, the Canadian government could create a special tax credit against Canadian tax bills for any payments of the tax to the U.S., Berg said. The one-time credit could be limited to just the income from assets subject to the levy, he said.
But Moody suggested that approach might not work. “My guess is there is little appetite for this within our current government, notwithstanding it may be the only practical method to provide real relief,” he said.
And overall, practitioners aren’t optimistic about a quick fix.
“While a diplomatic solution would be best, recent experience between Ottawa and Washington, D.C., leaves little hope of success,” Kim Moody, director of Canadian tax advisory with Moodys Gartner Tax Law LLP, said Aug. 17.
A Department of Finance spokesman said officials will “continue to engage with their U.S. counterparts,” but wouldn’t comment on possible solutions.
There may be some ways for taxpayers to mitigate the impact now, practitioners said.
U.S. taxpayers who need money to pay the tax bill could sell off their Canadian assets. However, it’s more likely they will borrow money to pay the tax, Berg said. Paying dividends from Canadian corporations is also inefficient, as it triggers taxes in Canada that can’t be recovered, he said.
Taxpayers could also increase the paid-up capital of their Canadian corporations, Reed said.
This would create a deemed dividend under Canadian tax law and a foreign tax credit in the U.S., but wouldn’t be a “distribution” that triggers the tax credit restriction under the draft regulations, he said.
Pierre-Paul Persico, a tax lawyer with Spiegel Sohmer, said one of his clients is caught in the “nightmare” despite filing and paying taxes in Canada and being fully U.S. tax compliant.
“Although U.S. multinationals rejoice as they can repatriate offshore cash at a discount, the overall sentiment is that this tax is unfair for U.S. individuals resident in Canada,” Persico said Aug. 16.
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