Following the passing of the House Bill on 16 November and the Senate Bill on 2 December, a joint House and Senate committee is now working to resolve differences between the two Bills, with the aim of enacting the Tax Cuts and Jobs Act by the end of December 2017.
There are a lot of similarities between the two Bills but also significant differences. This update summarises the key business tax similarities that are anticipated to form part of the final Bill: all will have a significant impact on businesses with a US footprint.
Corporate tax rates
Both Bills propose a Federal corporate tax rate of 20% (currently 35%), with the House Bill proposing the change takes effect from 31 December 2017 and the Senate Bill proposing the change from 31 December 2018. However, a slightly higher rate of 22% has also been mentioned, as a potential compromise for converging less popular aspects of the two Bills.
The House Bill repeals the 20% Alternative Minimum Tax whereas the Senate Bill retains this.
In addition, both Bills propose 100% expensing of capital expenditure from 2017, although the Senate Bill would phase this out from 2022 (neither proposal would be applicable for real property businesses).
Whilst the proposed reduced Federal tax rate looks competitive by international standards, there are no changes proposed to State taxes so the effective US tax rates are likely to result in the region of 26%-27% for many companies.
Mandatory Repatriation Tax
Both Bills proposal a mandatory repatriation tax on accumulated earnings and profits of foreign investments (with a 10% ownership threshold) and this is expected to apply to earnings and profits as at 2 November 2017. The rates range from 14%-14.49% on cash and cash equivalents and 7%-7.49% on non-cash assets but both Bills include a provision to pay this over eight years.
To prepare for this new tax, international groups will need to carry out a full analysis of the earnings and profits of foreign companies, categorisation, cost and cash flows.
Interest expense deductions
Both Bills propose new limitations for interest deductions (for both related and unrelated party debt). The first limit would be based on interest income plus 30% of EBITDA or EBIT (a difference between the proposals). The second limit would be a ‘worldwide leverage test’, currently proposed:
- By the House Bill to be the US corporation’s share of group EBITDA x 110% of the group’s net interest expense
- By the Senate Bill to be the extent the US corporation’s indebtedness exceeds a percentage (130% reducing to 110% by 2022) of indebtedness it would have if it applied the group debt:equity ratio to its domestic indebtedness.
The harsher of the first or second limits would apply although disallowed interest could be carried forward - for five years under the House Bill or indefinitely under the Senate Bill.
Coupled with the reduced corporate rate, the new interest limitations will have a significant impact on many established US inbound structures and US finance structures. Companies that have unpaid related party interest expense deductible on a paid basis may find it beneficial to pay this before 31 December 2017.
Both Bills propose a ‘partial’ territorial system with a 100% dividend participation exemption, referred to as dividend received deduction (DRD). The key points are:
- Qualifying conditions include a 10% ownership requirement.
- No deduction would be available in the foreign territory on payment of the dividend.
- Both Bills propose a holding condition, currently more than 180 days (House Bill) and more than 365 days (Senate Bill).
- The participation exemption would not extend to capital gains, eg on disposal of shares in subsidiaries - however, the Senate Bill proposes that to the extent a sale of shares (in 10%+ investment) gives rise to a deemed dividend (eg in respect of undistributed earnings and profits) that part may be treated as an exempt dividend.
- Foreign tax credits would not be available where the DRD is claimed.
- The DRD would not apply to pass-through entities or branches.
The proposed exemption will only apply to companies and, therefore, the use of pass-through entities and the US ‘check-the-box’ rules in US outbound structures needs careful consideration.
Intellectual property and intangible income
The House Bill proposes an effective 10% tax charge on passive intangible income (20% tax on 50% x ‘foreign high return amount’ (FHRA). FHRA is calculated as the excess of all controlled foreign company (CFC) income (other than income that is already taxed in the US, eg as Subpart F or effectively connected income (ECI)), over a routine return of around 8% on tangible property less interest expense of the CFC. Where a CFC owns high value IP, the routine return would be low, effectively taxing the CFC’s intangible income at 10%.
Under the Senate Bill, a US corporation would include within its taxable income ‘global intangible low-taxed income’ (GILTI) of its 10% foreign CFCs, in a similar manner to Subpart F income. A deduction of 50% of GILTI would be allowed until 2026, after which it would fall to 37.5%. GILTI is broadly the excess of the net CFC tested income (ie income other than that is already subject to US tax and less dividends from related parties) over its net deemed tangible income return (ie 10% on tangible property).
Both Bills allow for a foreign tax credit.
Both proposals are targeted at low taxed IP and are designed to encourage ownership of IP within the US. Groups will need to consider carefully the benefits and costs of any substantial reorganisation of their IP ownership and business model.
CFC look through rule
The current look through rule (which expires after 2019) excludes from a CFC charge (Subpart F) passive income received by one CFC from another CFC. The fact that both Bills propose making the look through rule permanent is welcome as this rule has been a useful exception from Subpart F charges for international groups.
The House Bill includes a proposal for a 20% excise tax on deductible outbound payments (other than interest) made to a related foreign corporation, unless the foreign corporation elects to treat the payment as effectively connected with a US trade or business (ECI) and as income attributable to a US permanent establishment. The excise tax would not be a deductible expense for the US corporation but the foreign corporation would be able to take into account ‘deemed expenses’, and a foreign tax credit would be permitted.
The intention is to encourage a related foreign company to elect for ECI treatment and for the excise tax to override tax treaties (by framing this tax as an excise tax on domestic corporations - similar to the UK’s Diverted Profits Tax).
The Senate Bill includes a proposal for a base-erosion-focused minimum tax (BEAT). The BEAT would apply to groups with at least $500m of US domestic turnover, where deductible payments are made to a foreign related (25% owned) party. The BEAT tax amount would equal the excess of 10% of modified taxable income (MTI) over the regular tax liability (after credits). MTI is broadly taxable income with the base erosion deductible payments added back.
Both proposals are complex and controversial, with potential for challenge from the WTO. It is not yet clear in which direction the two Bills will converge, but a ‘large group’ threshold would be a welcome exclusion for many groups.
It is important to remember that if US tax reform is passed through this reconciliation process, it may not all become permanent law – ‘sunset’ provisions are likely. Therefore, international groups should not undertake any radical action or restructuring of their businesses without careful consideration of all implications, for both the US and other territories.
For help and advice on international tax issues please contact Cory Blackmore or Nick Udal.
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