Executive summary
Canadian businesses with U.S. operations should assess key strategies and structures following sweeping U.S. tax reforms that could bring cross-border opportunities and challenges.
Canadian businessess and individuals could face significant tax changes following the adoption of new U.S. tax legislation—adding to a year already marked with economic uncertainty and tariff disruptions.
Canadian companies with operations in the U.S. may need to recalibrate key strategies in response to provisions in the One Big Beautiful Bill Act (OBBBA). While certain measures in the OBBBA may offer planning opportunities, others may increase compliance burdens and tax exposure.
The OBBBA’s potential effects on Canadian taxpayers are summarized below. While keeping track of this many updates can become extremely convoluted, taxpayers are encouraged to holistically examine their affairs and consult with the appropriate advisors in making any decisions in response to the OBBBA.
Table of contents
Repatriation of funds
- Business interest deduction
- R&D expenses
- Bonus depreciation
- SALT deduction limitation
- Key international tax provisions
Increased Canadian tax liability
- Canadian lenders with intercompany loans
- Deemed interest implications
- International tax provisions
- EIFEL
More room to repatriate funds tax-free into Canada
Certain elements of the OBBBA may provide Canadian corporations with more room to repatriate foreign earnings on a tax-free basis.
At a very high level, the Canadian surplus regime consists of notional accounts to track foreign affiliate (FA) earnings. The tax treatment of a dividend paid by the FA depends on which account the dividend is deemed to be paid from.
The exempt surplus account generally tracks the after-tax active business income earned by the FA resident in a country with which Canada has a tax treaty.
Dividends paid by such an FA out of its exempt surplus to its Canadian shareholder are typically deductible, resulting in no Canadian tax to the Canadian parent corporation on repatriation.
Business interest deduction (section 163(j))
This provision limits the amount of business interest expenses a U.S. taxpayer can deduct, including interest carried forward from prior years. It generally caps the deduction at 30 per cent of the taxpayer’s adjusted taxable income, which is determined by adjusting the taxpayer’s tentative taxable income for certain items.
The change allows taxpayers to add depreciation, amortization and depletion deductions when calculating adjusted taxable income for a limited period for tax years beginning after Dec. 31, 2024 and ending Dec. 31, 2029—thereby permanently shifting the calculation to the earnings before interest, taxes, depreciation and amortization (EBITDA).
The legislation ensures that business interest limitation applies before any capitalization, and any disallowed interest is not subject to future capitalization.
U.S. subsidiaries with significant debt could see their U.S. tax liability lowered due to higher interest deductions.
What this could mean for Canadian businesses
While a complete surplus analysis is extremely complex, at its simplest, operating FAs in the U.S. with higher interest deductions (and thus less U.S. taxes) could result in a higher exempt surplus because foreign taxes would otherwise normally reduce exempt surplus available for repatriation. Exempt surplus is beneficial as it allows an FA’s earnings to be returned to the Canadian parent as a tax-free dividend.
Changes to U.S. interest deductibility rules may allow U.S. FAs to deduct more interest, thereby reducing their U.S. taxable income and tax liability. Lower U.S. taxes increase after-tax earnings.
Since generally, exempt surplus calculations start with the FA’s earnings as calculated using U.S. tax rules, an increase in after-tax earnings could result in higher exempt surplus. This would enable larger tax-free dividend repatriations to the Canadian parent.
R&D expenses (section 174)
Under existing U.S. law, all research and development (R&D) expenses incurred in connection with trade or business must be capitalized and amortized—over five years for U.S.-based research and over 15 years for foreign-based research—using the straight-line method.
When a non-U.S. resident corporation that is considered a controlled foreign corporation (CFC)—equivalent to FA and controlled foreign affiliate (CFA) under Canada’s Income Tax Act—performs contract research for a U.S. parent, the U.S. parent must capitalize those costs over the 15-year foreign recovery period.
The new tax reforms restored immediate expensing of eligible U.S.-based R&D costs incurred in tax years beginning after Dec. 31, 2024. This allows U.S. taxpayers to accelerate the deduction of any remaining unamortized R&D costs that were capitalized in 2022 through 2024.
Foreign R&D expenditures remain subject to the current 15-year capitalization requirement.
What this could mean for Canadian businesses
Canadian businesses with active U.S. subsidiaries undertaking R&D functions or integrated cross-border operations could benefit from the U.S. tax rules allowing immediate expensing of R&D costs.
This treatment reduces the U.S. FA’s taxable income and tax liability, thereby increasing the after-tax earnings for an FA. The increase in after-tax earnings may contribute to a higher exempt surplus balance of active business FAs, which would allow larger tax-free dividends to the Canadian shareholder parent.
It could also influence cross-border structuring decisions as these new rules may incentivize Canadian businesses to relocate R&D activities to the U.S.
Bonus depreciation
The OBBBA permanently reinstated 100 per cent bonus depreciation for most qualified property acquired after Jan. 19, 2025. This includes tangible property with a class life of 20 years or less, consistent with prior bonus depreciation rules.
The legislation also introduced a new, temporary full expensing provision for qualified production property—a category of building property typically excluded from bonus depreciation due to its 39-year class life.
What this could mean for Canadian businesses
Canadian businesses with active U.S. subsidiaries that invest in U.S. manufacturing or production facilities may benefit from bonus depreciation under U.S. tax rules.
These incentives reduce the U.S. subsidiaries’ taxes and could result in higher exempt surplus for Canadian tax purposes as such increasing the tax-free repatriation capacity of the U.S. FA.
In addition, such deductions can affect transfer pricing and cost-sharing arrangements, especially where depreciation is a significant cost.
The OBBBA offers better deductions for interest, R&D expenses and bonus depreciation expenses, and may offer certain exempt surplus opportunities through lower foreign taxes. With this in mind, Canadian companies should consider the implications of numerous other complex FA rules and overall tax planning strategy.
Foreign tax credit availability
Canadian taxpayers who directly earn foreign-source income are eligible for foreign tax credit (FTC) relief for the income tax paid in a foreign country on business and non-business income.
Separate FTC calculations are prescribed for business and non-business income on a country-by-country basis.
All provinces and territories also allow a foreign tax credit, but only in respect of foreign non-business income taxes.
SALT deduction limitation
The U.S. state and local tax (SALT) deduction limitation was one of the more visible provisions of the OBBBA.
To help reduce double taxation, the SALT deduction allows certain taxpayers who itemize their deductions instead of taking the standard deduction to subtract specific SALT paid from their federally taxable income.
This deduction was previously limited to US $10,000 (or US $5,000 for married individuals filing separately), reducing the federal tax relief for many residents of high-tax states.
The new reforms raised the SALT limitation to $40,000 (or $20,000, for married separate filers) beginning in 2025 through tax year 2029. After that year, the limitation will revert to $10,000 (or $5,000 for married separate filers).
The limitation is phased down for taxpayers with modified adjusted gross income (AGI) over $500,000 ($250,000 for married separate filers) for the same period. Under this phasedown, the $40,000 limitation is reduced by 30 per cent of the excess of modified AGI over the threshold amount and not to be reduced below $10,000.
Both the limitation and the modified AGI threshold increased by 1 per cent each year through 2029.
The OBBBA made no changes to the deductibility of pass-through entity taxes (PTETs) by a pass-through entity. It also didn’t change the taxpayers that can make state PTET elections or the ability of U.S. taxpayers to make state PTET elections.
The final legislation omitted some changes that the House of Representatives approved on May 22 and others that the Senate proposed in its first draft of legislative text—more specifically, restrictions and, in some cases, complete limitations on a pass-through entity’s ability to deduct state PTET.
Accordingly, for most highly profitable flow-through entities, the analysis of whether to elect into a state PTET regime does not meaningfully change.
What this could mean for Canadian businesses
Changes to U.S. SALT deduction limits could significantly affect Canadian professionals and businesses earning U.S.-source income.
Canadian individuals earning U.S.-source income may benefit from a higher SALT deduction, thereby reducing U.S. tax liability.
However, this could correspondingly lower the amount of U.S. tax eligible for FTC in Canada, potentially increasing the Canadian tax liability and reducing net after-tax income.
Key international tax provisions
In addition to changes to the base erosion and anti-abuse tax (BEAT), the U.S. tax reforms include renames and updates to international tax provisions like the global intangible low-taxed income (GILTI) tax and the foreign-derived intangible income (FDII) tax.
GILTI is now referred to as net CFC tested income (NCTI) and FDII is now referred to as foreign-derived deduction eligible income (FDDEI). The name changes generally reflect a shift away from a previous focus on intangible income, reflected in the qualified business asset investment (QBAI) deduction.
GILTI was designed to limit offshore profit shifting, while FDII was intended to incentivize or reward taxpayers for keeping their business and IP in the U.S. and selling abroad. BEAT targets tax avoidance through related-party payments to FAs. These are particularly relevant to Canadian businesses with U.S. operations or FAs.
The new legislation reduced section 250 deduction rates; FDDEI drops to 33.34 per cent, while NCTI drops to 40 per cent. Both changes are permanent for taxable years beginning after Dec. 31, 2025.
BEAT was originally scheduled to increase to 12.5 per cent for taxable years beginning after Dec. 31, 2025. Instead, it will be set at 10.5 per cent on large corporations that make payments to foreign-related parties.
What this could mean for Canadian businesses
Canadian businesses with significant intercompany payments like royalties, interest or services that flow between U.S. and Canadian entities could benefit from the decision not to proceed with the previously proposed increase in the BEAT rate.
While conventional U.S. federal income taxes are generally creditable in Canada for FTC purposes, other U.S. levies, such as BEAT, are not considered creditable taxes under Canadian tax law.
Consequently, where U.S. entities incur BEAT on payments made to a Canadian entity, the Canadian taxpayer may face incremental tax exposure without the ability to claim a corresponding Canadian FTC.
However, the recent cancellation of the planned BEAT rate increase helps mitigate this exposure by reducing the magnitude of unrecoverable tax costs.
Higher Canadian tax liability
Canadian lenders with intercompany loans
When Canadian parent companies have extended intercompany loans to their U.S. subsidiaries or FAs, the relaxation of section 163(j) interest deductibility rules may lead to higher interest deductions being available to the U.S. FAs.
This, in turn, results in increased interest income for the Canadian lender, which is generally taxable in Canada.
While this may increase the Canadian tax liability, there may be a broader incentive for Canadian parent corporations to push debt into their U.S. subsidiaries or FAs to reduce overall U.S. tax liability.
Deemed interest implications
The shift in intercompany debt allocation may have deemed interest implications under section 17 of the Income Tax Act for the Canadian taxpayers on below-market-rate interest loans with non-residents of Canada.
Subject to transfer pricing limitations, the expanded section 163(j) may prompt Canadian taxpayer lenders to charge full arm’s length interest, or even higher rates where deductible in the U.S.
Consequently, while concerns under section 17 may be reduced because the structural incentives now align with charging market interest rates, the interest income earned in Canada should be fully subject to Canadian income tax.
International tax provisions
Broadly speaking, the nature of an FA’s income affects a Canadian parent’s tax liability depending on how it’s classified under the surplus regime.
While active business income from treaty countries may be repatriated tax-free, passive income generally triggers immediate Canadian tax through foreign accrual property income (FAPI).
The Canadian tax on such FAPI can be decreased by the foreign taxes paid on that income, known as foreign accrual tax (FAT).
With changes in key international tax provisions, as mentioned above, Canadian businesses with active U.S. FAs and cross-border IP structures may benefit from more favourable repatriation planning and enhanced U.S. tax efficiency on U.S. income.
However, provisions such as the FDII deduction and NCTI rules under U.S. tax law can reduce the effective U.S. tax rate on both active and passive income earned by FAs.
In the context of a U.S. subsidiary’s passive income that is FAPI, lower U.S. taxes could lead to a lower FAT deduction, which in turn results in higher net FAPI inclusion, potentially increasing the Canadian tax liability of the Canadian taxpayer.
In addition, where the U.S. FA earns passive income or holds passive-type assets which may be included in both NCTI and FAPI computations, income may be subject to taxation under both the U.S. and Canadian regimes.
Careful review is required to identify and mitigate such overlaps, especially when classifying income streams for surplus or FAPI purposes.
EIFEL
The newly introduced excessive interest and financing expenses limitations (EIFEL) rules may have significant implications for Canadian taxpayers with CFAs, particularly where those CFAs earn passive income such as FAPI and claim substantial section 163(j) interest deductions.
Specifically, the interest and financing expenses (IFEs) incurred by a CFA and deducted in computing FAPI may reduce the Canadian taxpayer's EIFEL capacity, and this increase the Canadian taxpayer’s overall Canadian tax liability.
In other words, a CFA's IFE can cause the Canadian parent to have a denied interest deduction because generally the CFA's IFE tied to FAPI will be included with the Canadian entity's IFE pool.
As a result, the Canadian parent may face restricted interest deductibility domestically—even where its own borrowings are unrelated to the CFA—because the CFA’s deductible IFE that is tied to FAPI should reduce the group’s overall deductibility capacity under EIFEL.
The origin of the Canadian taxpayer’s borrowings (whether domestic or cross-border) does not affect this outcome. As such, determining EIFEL reporting obligations with a CFA is more involved, as domestic entities must also factor in financial results and tax positions taken at the CFA level to determine domestic deductions.
Next steps for Canadian taxpayers
In a year already laden with uncertainty for Canadian businesses, U.S. tax reforms bring a blend of incentives and compliance challenges for cross-border operations.
Proactive planning is key to mitigate potential future Canadian tax impact related to U.S. tax amendments. Canadian businesses with U.S. operations, intercompany financing or FA structures should consider revisiting their cross-border tax planning and structures and evaluating the timing of investments while remaining cognizant of legislative developments south of the border.
RSM contributors
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Ved AswaniPartner -
Chetna ThaparManager -
Cassandra KnapmanManager -
Patricia ContrerasSenior Manager
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