At the time of writing, we were still waiting to see if the BBB goes through. No, I’m not talking about where the U.S. sovereign credit rating might be headed, but Trump’s ‘big beautiful bill’. After narrowly passing through the House of Representatives, it is now grinding its way through the Senate and it is unclear whether it will pass and, if so, how mangled it will look before heading back to the House.

This bill covers several areas, but the main drive was on extending the Trump 1.0 tax cuts – largely supporting the wealthiest segment of the population - plus a few extras. These include maintaining reduced personal income tax brackets, keeping the higher estate tax exemption, no taxes on tips, and preserving pass-through business deductions for small businesses. Some new elements cover areas like expanded child tax credits, a further reduction in the corporate tax rate and elimination of capital gains taxes for households earning under $200,000.

As I mentioned on this week’s conference call, the Congressional Budget Office has estimated that the measures in the bill will add $2.4 trillion to the national debt – something international bond investors have not been too happy with. Some traditional conservative Republicans aren’t too pleased either. In short, we don’t know if the bill is going to pass and what components of it will survive. Buried in those components are measures that can potentially impact Canadian investors, namely proposed IRC Section 899.

Let’s be clear from the outset. Section 899 can be viewed as just another example of the retaliatory revengeful actions by Trump and his circle of advisors. This is because the Bill targets countries that impose “unfair foreign taxes” and that includes Canada’s Digital Services Tax (DST), which is a 3% levy on certain digital revenues earned by large multinational enterprises from Canadian users. I don’t want to spend too much time on this, but this tax came about because of stalled international negotiations on global tax reform (Pillar One framework).

The former Trudeau government wanted to ensure that digital giants generating economic value from Canadian users contribute their fair share to Canada’s tax base. Note, similar taxes exist in France, the UK, and Italy and Canada actually intended to repeal the DST once an OECD-led global solution is in place. Unfortunately, Trump doesn’t like global negotiated solutions and prefers bilateral trade sledgehammers. Which brings us back to Section 899.

The proposed provision would significantly increase US federal income and withholding tax rates on foreign persons and entities including individuals, corporations, trusts, partnerships, private foundations, and foreign governments. Under the proposal, the tax rate applied to US portfolio income would increase by 5% each year, up to a maximum of 20% above the domestic tax rate of 30%.

As you know, there is a 15% withholding tax on dividends earned from share ownership of U.S. companies. If Section 899 goes through, this rate would increase to 20% in the first year and then rise to 50%. Up until now, Canada Revenue Agency has allowed for a recovery of US tax up to 15% in the case of non-registered accounts. For any taxation above that threshold, it is not clear what CRA would do. For non-TFSA registered accounts (like RRSPs, RRIFs, LIRAs, etc.), there was no withholding tax. For TFSAs, not only was a withholding tax applied, but it was unrecoverable.

Canadian corporations that receive dividends from U.S. subsidiaries are currently subject to a 5-per-cent withholding rate under the tax treaty between the U.S. and Canada, much lower than the statutory rate of 30 per cent. Under 899, their tax rate would increase by 5% every year until it is 20 points above the statutory rate, or 50 per cent. And, yes, it would stay at that level until Canada dismantled its so-called unfair tax.

So, where does that leave us? Well, if this Bill passes, there would definitely be a reduction in after-tax returns on U.S. stocks after January 1^st of next year. As such, we would imagine investors will see less incentive to hold U.S. dividend-paying stocks, at least at the margin. That is the direct effect on U.S.-domiciled investment returns, but there is an indirect effect too, stemming from other foreign investments re-allocating capital away from the U.S. to other locations. While this has been masked recently by a ‘home bias’ move into equities by U.S. investors, it is a headwind all the same if this Bill sees the light of day.

Strangely enough, this could be a bullish setup for Canadian dividend stocks. If Canadian and foreign capital retreats from U.S. names, that money needs a new home. As the chart above shows, Canadian equities typically deliver a higher overall dividend yield than the S&P500. Currently, the yield across Canadian stocks averages just above 2.5% according to LSEG Datastream estimates, compared with sub-1.5% yields for the S&P.  Currently, there are about 50 companies on the TSX with a dividend yield above 2.5% and with the exception of four of them, all of these have shown positive growth in dividend distributions over five years. 

This yield advantage plays well for income-oriented investors, but what about those who simply want to own U.S. stocks for growth? As the common disclaimer says, “past performance is not an indicator of future performance”, so one should not extrapolate the relative growth performance of U.S. equities vis a vis Canadian stocks to continue. That being said, under the proposed Bill, those stocks that pay little to no dividends are not going to be impacted, so one strategy might be to overweight the U.S. in the growth segment of a portfolio, while overweighting Canadian stocks on the dividend side.

Some have asked if the strategy of using hedged vehicles, like Canadian Depository Receipts (CDRs), is a way to circumvent Section 899. Unfortunately, no. We have been utilizing CDRs and other Canadian dollar hedged vehicles in the portfolio for quite some time now and while these insulate the portfolio from a continued drop in the value of the U.S. dollar, the tax treatment of CDRs is exactly the same as for U.S.-domiciled shares and the higher withholding taxes will apply. Again, if we are leaning towards U.S. growth (low or zero dividends), then we can do that via CDRs for a large cross section of large-cap names.

In short, Trump’s tax hammer may send global money shopping — and Bay Street could be the next retail destination. For investors, your weekend to-do list should include reevaluating your exposure to U.S. dividend stocks and exposure to the greenback in general.  There is no need for any snap changes, since the Bill isn’t law yet, though markets move on expectation, not legislation. In addition, even if the Bill does go through, implementation is not for another six months. Finally, adjustments in reaction to a less accommodative tax environment shouldn’t outweigh the larger factors influencing portfolios, like the state of the U.S. economy, fiscal policy, global capital flows and, of course, geopolitical developments. Raising the dividend withholding tax from 15% to 50% sounds big, but if you’re only getting a 2% dividend stream on a U.S. stock, the net effect is likely smaller than the movement in that stock’s price over the same period.

Playback details for this week's Market Update Call can be found below.

Toll-free dial-in number (Canada/US): 1-800-408-3053

Local dial-in number: 905-694-9451

Recording Passcode: 103765937#

Recording Expiry Date: 10-Jul-2025

On behalf of the Pyle Wealth Advisory team, have a wonderful weekend.

Andrew Pyle