The United States House of Representatives last week passed Donald Trump’s One Big Beautiful Bill Act, a voluminous and complex piece of proposed legislation that contains numerous tax amendments that could end up hurting Canadian pension plans and other investors.
The act includes things such as making permanent certain personal tax rate reductions (which were set to expire at year-end), a permanent estate tax exemption of US$15 million (annually indexed to inflation thereafter), tax exemptions on tips and overtime pay (I’m surprised this is moving forward), increases to state and local tax deductions and a variety of business tax proposals, including immediate expensing for certain capital assets.
Section 899 of the bill introduces retaliatory tax measures targeting foreign individuals, entities and governments that impose what the U.S. deems “unfair foreign taxes,” such as digital services taxes (DSTs) or global minimum tax top-ups, on U.S. companies.
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If enacted, it would override existing tax treaties and impose significantly higher U.S. tax rates — ranging from five per cent to 30 per cent — on passive income, real property gains and business profits for affected foreign investors.
For countries such as Canada, the implications could be severe if they fall within Washington’s definition of a “discriminatory foreign country,” or what I refer to as a “bad country.”
The DST that Canada recently implemented (other countries have, too) is certainly one of the reasons behind Section 899. The U.S., even under Joe Biden, made it clear it believed DSTs implemented by foreign countries unfairly attacked many American companies.
The U.S. has also not been impressed by the Organization for Economic Co-operation and Development’s push for a so-called global minimum tax, which Canada has embraced. This regime empowers countries to impose top-up taxes on the income of large multinational corporations even if that income was earned and already taxed elsewhere simply because the foreign tax rate was below a 15 per cent global minimum.
It’s being sold as a fairness measure, but the reality is that it allows high-tax jurisdictions such as Canada to reach beyond their borders and tax profits that have little or no real connection to their economy. It’s no surprise the U.S. sees this as an aggressive tax grab. The Biden administration also had concerns about this.
Given the above, it would not surprise me if the U.S. targeted Canada. The negative fallout for Canadians would be tremendous. For example, Canadian individuals and entities (corporations, trusts and partnerships) could face increased U.S. withholding tax rates of up to 30 per cent or more on U.S.-source dividends, interest, rents, royalties and capital gains on real estate.
If you’re a business owner and have U.S. operations through a corporate subsidiary, any dividends paid to a Canadian parent would be targeted. If your U.S. business is directly operated through a Canadian company, you could face higher branch profits tax.
Some tax geeks reading this will ask: How is that possible? Canada and the U.S. have a tax treaty that limits the rate of withholding tax to something far less than Section 899’s proposals. But the section is designed to explicitly override such treaties if you’re a resident of a bad country.
If caught, would Canada grant extra foreign tax credits to ensure that the recipient of the affected income would not be subject to double taxation? Doubtful under current Canadian law and administrative practice.
Another possible impact would be on the Canada Pension Plan and other normally tax-exempt pension funds. Section 899 could impose withholding tax on any U.S. source income received by CPP. This could have a material and negative impact on the entire CPP and, indirectly, pension holders.
What does Canada do next? You might logically think it would drop its admiration for the DST and the global minimum tax and repeal such provisions. But Canada is a proud member of the OECD. To drop such provisions to appease the U.S. would not be a good political look, especially with this “Elbows up” government. It might also affect future OECD tax policy development and contributions by Canada.
At a minimum, Canada — and all Canadians — will need to closely follow the movement of Trump’s bill, which will no doubt face hurdles in the U.S. Senate. But should Section 899 get passed in its current form, Canada may indeed be designated a bad country. If so, further tensions will arise that may be on par with that of tariffs. Diplomatic negotiations will be a must.
If Canada chooses to not try to resolve being a bad country, then we can expect Canadian investment in the U.S. to significantly shrink. Will the U.S. care? Doubtful. But the shrinking exposure of investment by Canadians into the U.S. should be of major concern to all of us. The U.S. is a monstrous investment target; Canada is not. Expect investment returns for all Canadians to dramatically shrink.
Prime Minister Mark Carney has recently suggested Canada must “reimagine” its economy in response to shifting global dynamics. But if Section 899 passes and Canada is designated a bad country, the fallout will be anything but imaginary: higher U.S. withholding taxes, pension fund exposure and serious disruption to cross-border investment.
Treaty protections would be ignored and our loyalty to OECD tax policies will be tested. There’s nothing beautiful about that. Elbows up? Hardly. Carney needs to implement some overall proactive tax measures before Canadians feel the pain.
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