US corporate tax reform

20 April 2017

President Trump’s proposals for sweeping corporate tax reform have generated great interest from many US and international businesses both during the election campaign and since he took office. The US tax system is widely regarded as discouraging inbound investment and making US businesses less competitive so tax reforms to improve its competiveness will be welcomed by both domestic and international groups.

Political considerations

Despite there being a Republican majority in both legislative houses, it is already clear that passing reforms will not be straightforward – the initial bid to repeal ‘Obamacare’ has already been shelved.

However, the consensus in favour of tax reform is likely to be stronger and, with some compromises to accommodate both the Republican Party’s tax reform ‘Blueprint’ and the President’s campaign pledges, passing new legislation in 2017 may well be possible. But what changes will emerge?

Core proposals

It is likely that the main rate of corporation tax will fall from the current 35% to 20% (or maybe as low as 15%) and the corporate Alternative Minimum Tax will be repealed. For sole proprietors and partnerships (‘pass-through’ businesses), the main tax rate could fall to 25% (or as low as 15%).

To pay for such a large tax cut, it is expected that the Republican Party ‘Blueprint’ will be followed to reduce tax deductions and allowances (for example, limiting interest deductions to the level of interest income and limiting the use of net operating losses to 90% of profits – although allowing loss balances to be carried forward indefinitely). However, allowing full expensing for the cost of new capital investments (both plant and machinery and intangible assets, excluding land) in the year of purchase is strongly supported as are credits to encourage investment in R&D.

For international businesses, reform proposals are likely to centre on a strategic shift from taxing worldwide profits of US businesses to a territorial approach (ie only taxing profits that arise in the US). The principal change would be allowing a 100% exemption in the US for dividends received from foreign subsidiaries and major relaxations to the US controlled foreign companies ‘Subpart F’ rules. For overseas profits accumulated outside of the US, a low rate of tax (10% or less) is likely when they are repatriated in future with companies able to spread the tax charge over a number of years (likely to be 8 years). Around the world, tax amnesties with low effective tax rates on disclosed funds have proved to be profitable for many tax jurisdictions. In much the same way, the accumulation of US owned profits held offshore is so large (estimated at $2 trillion) that even a low rate of tax could raise considerable funds for the President’s investment programmes if significant capital does return to the US.

If such a package of reforms is passed, it is expected that this will finally bring to an end the US Government’s battle against corporate ‘inversion’ mergers as the US becomes a much more attractive location for parent and holding companies.

Perhaps the most controversial proposals are in the area of border adjustments to effectively exempt exports from US tax while taxing imports. While a direct imposition of asymmetrical taxes would not be compatible with World Trade Organisation (WTO) rules, it may be possible for consumption based taxes (similar to value added tax) to be constructed in a way that does not offend the WTO. It may take some time to bring in such changes and precisely how these would work remains to be seen, but the outcome is expected to be revenue raising and be better for US net exporters than net importers.

Implementation issues

Whatever changes are achieved, it should be remembered that US state taxes also have an impact and if current trends are followed, it is by no means certain that individual states will follow the Federal proposals. It is reasonable to assume that they will lead to more complexity at a local level reducing or offsetting the impact in many situations.

Planning for change

All businesses with a presence in the US or US customers or supply chains are likely to be affected if substantive tax reforms are achieved. Alongside BEPS and Brexit, radical tax reforms in the US could make existing group structures less attractive and drive businesses to reconsider their operating models. 

For help and advice on international tax issue please contact Malcolm Joy or Ingrid Gardner.

Read about BDO’s US-UK tax desk.

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