U.S. tax reform has progressed rapidly in recent weeks. The House and Senate have passed their own bills, and now they must agree on a joint bill, which would result in the most significant changes to the U.S. tax system since 1986. Tax reform could pass before the end of 2017, with the legislation mainly effective as of January 2018.
The international aspect of the legislation has focused on adopting a territorial tax system similar to other tax jurisdictions, but the legislation could be viewed as just a small step toward a territorial system. The territorial application for dividend treatment only applies to corporations, and new anti-base erosion tax measures for U.S. corporations are being added, which dilute true territorial tax treatment.
The bills also impose current tax on the accumulated foreign earnings of a U.S. corporation’s foreign subsidiaries as part of a toll charge to the new system, albeit at lower rates. And not only is the current onerous U.S. Subpart F regime retained, it is significantly expanded upon in both bills.
The bills also tax income of foreign subsidiaries of U.S. companies generated from the use of foreign intangibles at minimum tax rates. Other similar provisions, such as the ability to repatriate intangibles to the U.S. tax-free, effectively incentivize U.S. multinational corporations to move or to keep group intangibles onshore.
Payments to foreign-related parties also are subject to increased U.S. tax, especially for larger foreign-owned companies. Although the feared border adjustment tax was dropped from consideration earlier, similar provisions appear in the current legislation.
U.S. companies with foreign subsidiaries and foreign inbound companies will need to carefully re-evaluate their existing global supply chain and capital structures if the lower U.S. tax rate and other proposed changes take effect.
Specific Provisions of Interest to Foreign Inbound Companies
- Reduction of corporate income tax rate to 20 percent. The lowering of the corporate income tax rate from 35 percent would contribute to international restructuring and potential changes to a corporation’s global supply chain. U.S. subsidiaries of foreign companies would benefit from the rate change.
- 100 percent expensing for business property. A 100 percent cost deduction for business equipment in the U.S. could motivate increased investment of plant and business operations in the U.S., especially when considered in conjunction with the other tax reform changes for multinational companies. Investment in U.S. business assets by foreign-owned U.S. companies should benefit from this provision.
- Limitation on interest expense deductions. The current rules limiting the interest expense deduction of foreign-owned U.S. corporations would be modified and broadened. The net business interest deduction for both related and unrelated party debt for all U.S. taxpayers would be limited to 30 percent of adjusted taxable income. A new provision also would limit the deduction for interest expense of a U.S. corporation that is a member of an international financial reporting group.
The interest limitations likely would result in outbound and inbound multinational corporations carefully re-evaluating their global capital structures.
- 100 percent deduction for dividends received from foreign subsidiaries. Both bills provide for a 100 percent deduction for dividends received from a foreign corporation to a 10 percent U.S. corporate shareholder. The dividends-received deduction would not apply to foreign branch income and would not apply to individuals or pass-through entities such as U.S. partnerships and LLCs.
This deduction could apply to foreign-owned U.S. companies that have non-U.S. subsidiaries. It is expected that this provision would result in increased repatriation of cash dividends from foreign locations into the U.S. over time.
- Transition tax on deemed repatriation of foreign earnings. A U.S. shareholder of a foreign corporation would have to include in gross income its share of the accumulated deferred foreign income of its foreign corporations as of November or December 2017. The mandatory inclusion would be subject to tax at reduced rates of between 7.5 percent and 14.5 percent, with the higher rate to be applied to cash-type earnings.
This provision also could result in a significant repatriation of cash into the U.S., depending on business needs and incidence of foreign withholding taxes. In addition, this provision could apply to foreign-owned U.S. companies with non-U.S. subsidiaries.
- U.S. tax on foreign intangible income. Both bills have proposed provisions that effectively would tax the intangible income of a U.S. company’s foreign subsidiaries at a 10 percent or 12.5 percent minimum tax rate. Taxable foreign intangible income would be deemed income in excess of a designated routine return on the tangible depreciable business assets of the foreign subsidiary. The bills also provide for tax-free repatriation of foreign-owned intangibles into the U.S, which would be a significant change.
This treatment effectively would assume that all returns on foreign subsidiary intangibles erode the U.S. tax base regardless of where, when, or by whom intangibles were developed. They could be a significant motivation for companies to retain or bring intangibles into the U.S.
- Excise tax or anti-base erosion tax on related-party payments. The bills would subject deductible payments made by a U.S. corporation to a related foreign corporation, such as a foreign parent, foreign subsidiary, or other related party, to either a nondeductible 20 percent excise tax or a 10 percent base erosion tax.
This related-party treatment, applicable over a certain threshold, could significantly affect large inbound companies and could affect payments from outbound U.S. companies to their foreign subsidiaries.