US tax reform takes a significant step forward | KPMG | IE

US tax reform takes a significant step forward

US tax reform

In the early hours of 2 December 2017, the United States (US) Senate passed its version of tax reform (the Tax Cuts and Jobs Act) which contains proposals to enact wide-sweeping US tax reform measures.

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Given the small Republican majority, passing the Senate was seen as one of the highest hurdles to enacting tax reform and therefore some form of tax reform is now seen as increasingly likely.

The Senate’s tax reform bill differs from that passed by the US House of Representatives (the House) on 16 November, and the next step is to get both chambers of Congress to negotiate and agree a uniform approach to tax reform. This could involve a formal House-Senate conference, informal negotiations, or even (although unlikely) the House simply accepting the Senate tax reform bill.

While there is no hard and fast deadline by which to place a bill on the President’s desk for signing, there is significant political pressure on both houses to enact tax reform legislation before the end of this year.

Both bills contain very significant proposed changes to the US federal corporate income tax regime. If enacted as proposed, the measures could make the US significantly more competitive, from a tax perspective, as a location to do business in the future.

The measures the House and Senate tax reform bills have in common include:

  • A reduction in the federal corporate income tax rate to 20% (although this would be delayed to 2019 under the Senate bill, and notably President Trump remarked this could in fact rise to 22%).
  • A move to a 100% dividend exemption regime for dividends from non-US companies (requiring a 10% holding).
  • Mandatory taxation of the un-repatriated overseas profits of the subsidiaries of US corporations (with the ability to defer payment of the tax in 8 instalments). The House proposed tax rate on repatriated profits is 14% for profits held in cash and liquid assets and 7% for illiquid assets (the rates are c. 14.5% and c. 7.5% in the Senate bill).
  • A time limited ability to expense 100% of expenditure on capital assets against taxable profits (with some differences between the House and Senate bills’ scope of eligible assets).
  • Preservation of the R&D tax credit for R&D activities carried on in the US (although there are suggestions that the continuance of an Alternative Minimum Tax in the Senate bill will undermine the benefit here).

The tax measures in both bills are projected to increase the US deficit even after taking into account the effects of the expected boost to US economic activity arising from the tax reduction measures.

In order to pay for some of the tax revenues lost as a result of the above measures, both the House and Senate bills include a series of tax generating measures. If enacted, these could be expected to change the measure of US taxable profits for groups carrying out business in the US. These include:

  • Limiting deductions for interest expense to 30% of defined profits. The House bill proposes that the 30% limitation would set by reference to EBITDA, with the Senate bill proposing a narrower base for capping interest deductions of 30% of EBIT. Both bills contain additional measures to limit the scope for international groups to deduct finance costs against US taxable income that are disproportionate to the level of finance costs on external debt borne by the worldwide group. The measures apply to larger groups and the House and Senate bills use slightly different measures to achieve this additional protection of the US tax base.
  • Both bills contain restrictions on use of tax losses (NOL’s).
  • Both bills propose additional taxes on payments by US based business to foreign related parties. The House bill proposes a 20% excise tax on a broad range of payments made for goods and services to group members (in excess of an annual threshold of US$100m) which does not apply where the related payment is taxed in the US at the 20% rate, net of offsetting foreign taxes on the deemed measure of profits from the payments. The Senate bill proposes a 10% tax on a range of payments to foreign related parties, excluding payments for cost of goods sold.
  • Imposing a minimum tax on profits arising to foreign subsidiaries of US multinationals (MNCs) from the exploitation of intangible assets. Both the House and the Senate measures should not result in additional US taxation if the combined profits of the foreign subsidiaries are taxed at a rate of at least 12.5% (this is calculated on an averaged global basis as opposed to a country by country and under US rules for working out taxable income).
  • The Senate bill also proposes a reduced rate of US corporate income tax on certain foreign source income from intangible assets arising to US companies which could see the income subject to a 12.5% US corporate income tax rate (increasing to 15.625% from 2026). Some concern has been expressed that this provision might violate WTO rules as, in effect, an illegal export subsidy.
  • The Senate bill also includes a number of measures targeted at hybrid mismatches e.g. seeking to deny the dividend exemption if the dividend was deducted by the foreign payer.

What do the proposals mean for Irish based business?

As can be seen from the above, although there are differences in the details between the House and Senate bills, there is much in common in the proposed measures whether related to personal or business tax reform.

Ireland’s 12.5% rate of corporation tax remains attractive when compared with the proposed US combined federal income tax and state rate tax which is likely to see most US businesses taxed at corporate income tax rates of circa. 25%.

A threshold foreign minimum rate of tax of 12.5% applies to profits from exploiting intangible assets under both the House and Senate bills before additional US tax applies to these profits. The taxable profits of most businesses in Ireland are taxed at a rate which is close to the Irish corporation tax rate of 12.5% meaning that Irish based business should broadly be subject to tax at a rate that equates to the target US minimum tax rate on such profits (although it is important to note that the taxable income base and rate test here is calculated under US rules and on a global basis, including other foreign non-Irish affiliates).

Irish based business operating in the US

For Irish based business operating in the US, the proposed restrictions in relation to interest deductions (which are not grandfathered for existing debt) as well as the possibility of additional taxes applying to payments for services (and goods) purchased from non US group members, could have significant consequences, in particular for those groups which are heavily leveraged and/or rely on sale of goods and services from non-US group companies to US subsidiaries.

Measures which propose a 100% expensing of asset expenditure together with the continuation of the R&D tax credit should improve the US after tax position of their investment in US based business. However, these positive measures are unlikely to effectively counter balance the potential tax costs arising from the above measures.

Irish groups with US operations will need to carefully monitor the proposals in order to understand their potential impact on existing financing arrangements and business supply chains for US based operations.

US parented groups

For US parented groups looking to expand outside the US, the proposals, if enacted, would mean that they would not face additional US tax if their total overseas foreign derived intangible profits were taxed at a rate of at least 12.5% (calculated on an aggregate basis and under US principles). Profits taxed at this minimum tax rate could be repatriated tax free to the US.

Of some concern from an Irish competitive perspective are the proposals contained in the Senate bill to offer a reduced onshore US tax rate on foreign source intangible profits. These measures, which are not contained in the House bill, could see foreign source profits from intangible assets taxed in the US at a federal corporate income tax rate of 12.5% (increasing to 15.625% from 2026).

Conclusion

The development of these measures will be watched with very close interest over the next couple of weeks. There are expected to be intensive negotiations between the House and Senate to reconcile the bills if President Trump’s ambition is to be realised and significant US tax reform measures are enacted by the end of this year.

Please view the diagram below which sets out the pathway to US Tax Reform.

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