On 22 December 2017, President Trump signed into law H.R. 1 (formerly the ‘Tax Cuts and Jobs Act’) and its provisions generally took effect from 1 January 2018 – although some changes will be phased in. This article summarises the key provisions that are expected to affect international businesses with a US footprint.
Corporate tax rates
From 1 Jan 2018, the Federal corporate tax rate is a flat 21% (previously progressive rates up to 35%): this new rate is permanent, not time-limited. Despite this substantial reduction, when combined with State and local taxes, the effective US corporate rate will be in the region of 26% - higher than the average across most OECD countries.
The corporate tax base will also be reduced by the following measures:
There will be 100% first year relief for capital expenditure for all expenditure on assets acquired and placed into service from 23 September 2017 up to the end of 2022. From 2023 to 2027, this relief will be phased out over five years by reducing the expense amount by 20% per annum.
For companies, the new law adopts a 100% dividend participation exemption, referred to as dividend received deduction (DRD) - the key points are:
- To qualify, the US company must own 10% of the voting power of the foreign corporation and a holding period requirement of at least 365 days of the last 731-day period, beginning on the date that is 365 days before the dividend in paid.
- The DRD does not apply to a dividend if a deduction is available in the foreign territory on payment of the dividend.
- Foreign tax credits are not available where the DRD is claimed.
- The DRD does not apply to pass-through entities or branches, nor would it be available for real estate companies nor regulated investment companies.
- Passive foreign investment companies are excluded.
The exemption does not extend to capital gains, eg on disposal of shares in subsidiaries. However, the DRD is available for certain deemed dividends arising in respect of undistributed earnings and profits on a sale of shares in 10% owned foreign corporations, that are held for at least one year.
However, other measures will increase the corporate tax base:
- Interest expense deductions
The new limitation rule for net interest expense deductions is simpler than either the original House or Senate Bills and limits a business’s interest deduction to 30% of ‘adjusted taxable income’ (for both related and unrelated party debt). The new limitation applies to tax years beginning after 31 December 2017, with unused interest deductions being available to carry forward indefinitely. Adjusted taxable income will be measured as EBITDA from 31 December 2017 to 1 January 2022, and subsequently as EBIT.
The use of Net Operating Losses (NOLs) is limited to 80% of taxable income for losses arising in tax years beginning after 2017. NOLs arising before 31 December 2017 may still be utilised in full. Corporations will therefore be required to separately track their NOLs. NOLs can be carried forward indefinitely but can no longer be carried back.
- Mandatory repatriation tax
The rates of the one-off mandatory repatriation tax on accumulated earnings and profits of foreign investments (with a 10% US corporate ownership threshold) will be 8% for non-cash assets and 15.5% for cash or cash equivalents. This will apply to earnings and profits as at 2 November 2017 or 31 December 2017, whichever is the greater. Corporations can elect to spread the charge over a period of eight years paying 8% of the total charge in each of the first five years, followed by 15%, 20% and 25% respectively in the following three years. The tax is paid on a corporation’s normal annual due dates for payment in each of the years.
- Intellectual property and intangible income
From 1 January 2018, a US corporation must 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 is allowed until 2026 (except for RICs and REITs), after which it would fall to 37.5%.
GILTI is broadly the excess of the net CFC tested income (ie income other than that already subject to US tax and less dividends from related parties) over its net deemed tangible income return (ie 10% of qualified business asset investment (QBAI) on tangible property, less interest expense). Companies can claim a foreign tax credit of 80% of the foreign taxes attributable to the tested income.
In addition, there is now a preferential rate of tax on ‘foreign-derived intangible income’ (FDII) at an effective rate of 13.125% on excess returns earned directly by a US corporation from foreign sales and services, including income from licences and leases. FDII is broadly a US corporation’s ‘deemed intangible income’ ie foreign income not attributable to a CFC or foreign branch less 10% of QBAI. This effective tax rate rises to 16.406% from 2026.
The current look-through rule (which expires after 2019) that excludes from a CFC charge (Subpart F) passive income received by one CFC from another CFC will not be made permanent (as originally proposed).
A modified version of the Senate Bill’s proposals for a base-erosion-focused minimum tax (BEAT) have been adopted. The BEAT will apply an additional tax charge to domestic corporations that are members of an international group that has at least $500m of US domestic turnover (average over three years) and a base erosion percentage of 3% or higher for the tax year.
Base erosion payments are amounts paid to a foreign related (25% owned) party, that are deductible payments. The base erosion percentage broadly represents base erosion payments made to related parties divided by total allowable deductions for the tax year. Where this exceeds 3%, the company must calculate its modified taxable income for the year - broadly taxable income with the base erosion deductible payments added back.
The BEAT tax amount will be 5% (rising to 10% from 2019 to 2024, and 12.5% from 2025) of a company’s modified taxable income less the company’s regular tax liability for the year (after credits).
This major reform will have profound effects on the way groups with a US footprint are structured. For example, the reduced corporate rate, the new provisions for interest limitations and NOLs will have a significant impact on many established US inbound structures and US finance structures.
To prepare for the new repatriation tax, international groups need to carry out a full analysis of the earnings and profits of foreign companies, their categorisation, and model the cost and cash flows.
In addition, the use of pass-through entities and the US ‘check-the-box’ rules in US outbound structures needs careful consideration as they will not benefit from the new DRD. In many cases, a detailed review of a group’s IP ownership and business model will be needed as the new ‘GILTI’ rule targets low taxed IP and the FDII is designed to encourage ownership of IP within the US.
As always, 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 get in touch with your usual BDO contact, or Nick Udal or Cory Blackmore.
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