Business people reading about a free trade deal might wonder if that means a free tax deal. We as business people tend to think of tax and trade together. Every business decision involves a cost benefit analysis and if trade is a benefit then the balancing cost we consider is tax. If we trade more does that mean we tax more or tax less? The two really are linked. It is hard to think of any transaction a business person does where he / she does not have to think of tax.
Let’s ask the question: what happens for tax when trade takes place between Canadians and another country? The first thing to consider is actually clarifying which two (or more) countries are involved. For example, Canada has a tax treaty with China and a separate tax treaty with Hong Kong. Some people might not realize that buying a product from Mainland China and importing it via Hong Kong might be different than importing it directly. The second thing to consider is whether there is a tax treaty between the two countries. Canada is a trading nation and has a large network of treaties with other countries. Tax treaties between nations are an important tool of governments to either encourage or discourage international trade. The tools within the treaty are 1) the rate of tax charged on transfers of profits, services, products etc. between the countries 2) the determination of which country gets the primary tax on the profits etc.
There are general rules of thumb with tax treaties but there are more cases of individual special rules in treaties than there are of completely standardized rules in treaties. For example, Tax Treaties that Canada has with other countries generally cover who gets to tax profits on natural resources and contain some clear rules on
who gets to tax this profit. This focus on natural resources in our treaties is not necessarily in treaties between other countries. The point is that governments are using tax treaties as a tool to promote trade or discourage trade and to keep tax revenues in the country or give up tax revenues if they feel that will encourage some
other positive activity. The fact that Canadian tax treaties cover natural resources tells us that this was important to the Canadian government when they wrote the treaty.
Business people want to pay close attention to tax treaties and the rules of where they are taxed and how much they are taxed because the tax amounts paid can have a huge effect on the net profits at the end of the day. Many readers will remember articles in the paper about large multinational companies avoiding taxes by structuring their profits and businesses to be in tax friendly countries. So for example, a multinational might put a certain office that has a limited function in a country seemingly just to take advantage of that country’s lower tax rates. For example, just recently Yahoo announced that it is moving its European operations from Switzerland to Ireland for tax reasons.
I suggest that there are two important thoughts for business people hiding under the surface here. First and foremost. You don’t need to be a large multinational to “treaty shop”. Treaty shopping is looking for a tax jurisdiction that favours your business with low tax rates or other incentives. And second and often a huge
surprise to Canadians; Tax rates in Canada and the tax system in Canada are low and efficient. What does that mean? Low taxes are pretty clear. Foreign businesses in Canada can expect to pay income tax in the 25% range, which is the same rate as medium and large Canadian businesses pay. Whereas small local businesses in Canada can expect to pay income tax rates in the 15% range. These rates are very competitive when compared to other industrialized countries. Plus these rates are integrated through the Canadian network of tax treaties with other nations. Integrated means that when you pay tax to both countries you get a system of foreign tax credits. Here is an example; let’s say a company does business in a country with a local rate of 30% and also in Canada with 25%. With integration you don’t add the rates to come up with 55% tax instead you subtract the Canadian taxes paid from the local rate of the international business to get 25% paid to Canada and 5% paid to the other country totaling 30% tax paid. However integration can also mean that when structured correctly if a Canadian with a tax rate of 15% doesn’t have to worry about a 30% rate in the other country. We can often structure the tax to get the rate down to the 15% rate.
Circling back to the opening question. Does free trade mean free tax? No it doesn’t but it can mean that when new opportunities open up because of a free trade deal there are also tax treaties in place to encourage low and efficient taxation. It would be pointless to encourage free trade and to tax it so heavily that no one wants
to trade. Let’s celebrate our new Canadian – European Union free trade deal and start trading more and of course paying more low taxes on our new profits.
If you have any questions regarding free trade, please call or email us.