Duties and deductions in Canada and the US: the taxing truth about tariffs

Siwei Chen
Borden Ladner Gervais, Calgary
SChen@blg.com

The era of tariff-free global trade has long enabled supply chains to operate with stability and predictability. While pricing, supplier selection and customer relationships have always been influenced by various factors, the absence of tariff-related friction established a status quo; one that is now undergoing significant disruption.

Another critical factor to evaluate for all Canadian taxpayers impacted by tariffs is their deductibility and the legal grounds based on which such deductions may be claimed.

What you need to know

The tariffs considered herein include tariffs imposed by the United States on Canadian exports to the US (‘US tariffs’) and Canadian retaliatory tariffs imposed on imports from the US (‘Canadian tariffs’).

US tariffs on exported goods

Because Canadian exporters are not the party that is legally obligated to pay US tariffs (in their current form), there is no basis for a direct deduction related to these tariffs for a Canadian exporter to the US. However, if a Canadian exporter negotiates a price reduction on sales inventory to accommodate a US buyer affected by US tariffs, the reduced revenue may be effectively equivalent to a deductible expense. Nonetheless, this reduction is a result of pricing adjustments rather than a direct tariff payment.

Canadian tariffs on imported goods

The deductibility of Canadian tariffs depends on various factors and may fall into one of the following categories:

• income deduction in the year incurred;
• deductible as part of the tax depreciation of a capital asset; or
• non-deductible capital outlay (other than depreciable property).

Income deduction

A Canadian importer of raw materials or inventory subject to Canadian tariffs may argue that these tariffs qualify as an income deduction in the year incurred, specifically as part of the cost of goods sold or property consumed during the year as part of their business operations, provided they meet the relevant accounting and legal standards. However, the determination of whether an expense is deductible for tax purposes is ultimately a legal question, not an accounting one.[1] Whether the deduction of a tariff as part of the cost of goods sold or current expenses ‘presents an accurate picture of a taxpayer’s profit for a given year’ (or represents, for example, a capital outlay to preserve a customer base in the US) remains to be determined.[2]

The key consideration is whether a tariff aligns with the legal requirement that an expense must be incurred ‘for the purpose of gaining or producing income from the business or property.’[3] Some taxes (like income taxes) are not deductible because they arise as a consequence of earning income rather than for the purpose of earning income.[4]

For example, a base payment to the province of Saskatchewan calculated by multiplying the number of tonnes of potash sold by the rate of tax was not deductible because it was triggered by the sale of potash. Had the trigger for the tax been the establishment of a mine, then such an amount could have been deductible. However, because the base amount was incurred as a consequence of the sale of potash, it was not deductible.[5] A Canadian taxpayer importing goods may be distinguishable because a tariff is applied on the input to their supply chain rather than the output at the time of sale.

Other taxes, such as goods and sales tax (GST)[6] and foreign capital taxes imposed on corporations for conducting business in another jurisdiction, have been deemed deductible on the basis that the tax liability did not arise on the sale of any products, but simply by having an establishment in the other jurisdiction.[7]

For a Canadian business, the fact that a tariff increases operating costs or may affect profitability is not, in itself, sufficient to establish deductibility.[8] The analysis hinges on whether the tariff is an inherent cost of earning business income.

Capital expenditure

Depreciable capital property

For depreciable capital property, the undepreciated capital cost (UCC) is calculated based on the taxpayer’s ‘capital cost’, a term not explicitly defined in the Income Tax Act. However, the UCC calculation specifically includes amounts paid for countervailing or anti-dumping (CAD) duties in respect of depreciable property.[9]

Neither US tariffs nor Canadian tariffs currently qualify as CAD duties, nor are they expected to be reclassified as such in the future. Therefore, whether Canadian tariffs can be added to the UCC depends on whether ‘capital cost’ captures Canadian tariffs, which requires an assessment of the law and relevant facts.

Non-deductible capital outlay

If a Canadian tariff does not qualify as a business expense or an addition to the UCC, it may be considered a capital outlay that is not deductible unless a specific provision allows for its deduction. Generally, deductible capital outlays are outlined in subsection 20(1) of the Income Tax Act.

While subsection 20(1)(vv) allows for the deduction of CAD duties, Canadian tariffs do not fall into this category, meaning this provision does not apply.[10] The existence of this carve-out suggests that: (a) it is possible a Canadian tariff could be considered a non-deductible capital outlay; and (b) if Canadian tariffs are not deductible in the year incurred or added to the UCC of a depreciable capital asset, it is not deductible.