US tax reform: six key changes for international business
The long awaited US tax reform bill has been released by House Republicans. Media reports suggest that Democrat support will not to be needed to get it passed, because of the limited impact on the deficit – that is estimated at $1.5tn over 10 years. It contains some very significant changes for international business.
As anticipated, the corporate tax rate would be reduced from the current 35% down to just 20% starting in 2018. This is seen as a major boost to American companies’ international competitiveness and to American jobs.
While dividends from foreign companies are taxable under the current US rules, the bill introduces a full exemption for dividends from 10% foreign subsidiaries, again as from 2018. This is also seen as a means of levelling the playing field with foreign businesses when selling products or services abroad by removing an additional layer of tax on those foreign profits. It is also designed to remove the current incentive for American companies to retain their foreign profits outside the United States rather than repatriating them.
The new participation exemption would apply to all distributions from foreign subsidiaries made after 2017. However, in order to eliminate the advantage of prior year earnings that have been kept outside the US a one off tax would be levied at a rate of 12 per cent, or if the profits have been reinvested in the foreign subsidiary’s business, at a rate of 5%.
The bill includes three provisions aimed at preventing erosion of the US tax base.
The first is aimed at companies that shift income out of the US by allocating it to intangible property or risks held by low or no taxed foreign subsidiaries. The new rule would tax income earned by those foreign subsidiaries that is above a ‘routine’ level at an effective rate of 10%.
The second base erosion provision would be a worldwide debt cap for US corporations belonging to large groups (gross receipts in excess of $100 million). This would broadly limit the net interest deductible by a US corporation by reference to its share of the group’s worldwide earnings. The new limitation is seen as a means of discouraging excessive leverage of US companies, in conjunction with the new exemption for foreign dividends.
The third and final base erosion measure would be a 20% levy on deductible payments – like the purchase of goods - made to a foreign related party unless, broadly, the foreign related party elects to pay US tax on its profits. The idea is that this would eliminate the U.S. tax benefit afforded to multinational companies that make significant deductible payments (i.e. at least $100 million) to foreign affiliates by imposing full U.S. tax on the related profits irrespective of where they are booked. This rule would apply to tax years beginning after 2018.
The plan now is to get the bill through both Congress and Senate in time for President Trump to sign it into law before the end of the year, but whether such a tight timetable can be met remains to be seen.
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