NCPA - National Center for Policy Analysis

Canada's Experience with Territorial Taxation

November 16, 2012

Recently, there have been several debates over the merits of a territorial tax system. In essence, such a tax system allows a company to be exempt from any domestic taxes for earnings made in another country. The United States currently adheres to a "worldwide" tax system in which earnings that are made abroad are still subject to the U.S. tax code. Canada provides a model for the United States to look at, as it has essentially pivoted to a territorial tax system to much success, says the Tax Foundation.

Canada's tax system is sometimes referred to as a "hybrid system" because it does not adhere fully to a territorial tax system. Instead, Canada creates treaties with other countries and any Canadian company that makes income in one of those countries is exempt from paying domestic taxes. But since Canada has expanded this treaty network to include 91 countries and all major trading partners, it is considered a territorial tax system. Theoretically, however, Canada can still tax income earned in non-treaty countries.

To keep its tax base from eroding, Canada treats all passive income as Foreign Accrued Property Income (FAPI). This classifies interest, royalties, rent and other passive investment income and income from unincorporated branches as taxable. This prevents companies from shifting to low-tax jurisdictions.

Canada continues to make its tax system highly competitive.

  • Canada's corporate tax rate has been lowered from 42.9 percent to 26.1 percent.
  • In 2007, the dividend exemption was applied to affiliates in countries with a bilateral Tax Information Exchange Agreement.
  • Furthermore, Canada has facilitated foreign investment by Canadian companies.

As a result of these competitive tax changes, Canada has experienced stronger economic performance.

  • Canada's economy has grown at an average real rate of 2.61 percent since 1995.
  • This is 0.02 points stronger than the U.S. average.
  • Moreover, more jobs have been added to the Canadian economy.
  • Finally, Canada is still able to yield consistently large tax revenues that have out-collected the United States.

Source: "Canada's Experience with Territorial Taxation," Tax Foundation, November 12, 2012.


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