The US has become much more competitive due to US Tax Reform. But alongside every carrot is a big stick. What are the carrots and sticks of reform?
The 2017 US Tax Reform represents the most sweeping overhaul of the tax system in over 30 years.
At the forefront of the reform is the headline-grabbing cut in corporate tax, intended to boost economic growth. Looking beyond this rate cut, though, we find that the reforms have thrown up more questions than answers.
Businesses will have to become familiar with an entirely new tax lexicon: Global Intangible Low-Taxed Income (GILTI), Foreign Derived Intangible Income (FDII), and Base Erosion Anti-Abuse Tax (BEAT). They will have to pick their way through the often-conflicting interplay of these measures and take a view on how the tax reform will impact financing strategies and business structures.
The reform proffers carrots in one hand and waves sticks in the other. The biggest carrot of all is obviously the headline drop in corporate income tax, down from 35% to 21%. This shift transforms the US in global tax terms. Among industrialised nations it previously had one of the highest tax rates; now it has one of the lowest.
This, coupled with another carrot - the lower rate of tax on deemed intangible income earned by foreign affiliates in relation to US intellectual property - is designed to incentivise firms to create and develop more intellectual property in the US and to move existing IP there. This measure reaches beyond intangible income, to include excess returns above a certain fixed return on tangible assets.
It certainly makes looking at new IP investment in the US, as well as hard assets, a potentially attractive proposition. However, it may not necessarily make sense to move existing intangible property to the US. And that’s because of some rather large sticks.
For instance, if an organisation decides to bring its IP back to the US it’s clear that they will be welcomed with open arms. However, if that transaction is not structured correctly, this might trigger BEAT, a provision that targets deductions arising from related party payments, including IP.
In addition, there is now a minimum tax on foreign earnings deemed received by US-based corporations from intangibles (GILTI). Foreign-parented companies don’t necessarily have to worry about it, but it’s certainly a higher tax imposition on any excess profits that US companies generate overseas.
This might tempt businesses to bring their IP back to the US, but the assumption that they will automatically be penalised for IP that is owned offshore might be wide of the mark. If an organisation has foreign tax credits, or most of its foreign footprint is in relatively high tax jurisdictions, the reverse could be true. Then there is the fact that the sticks get more punitive. The BEAT goes up from a rate of 10% to 12.5% from 2025, and GILTI goes up from 2026. Ultimately, these calculations are highly complex and need to be modelled for each taxpayer.
The reform also expands on the definition of intangible property, potentially increasing the cost of any IP transfer. Essentially, if you are a US company that wants to move any intangible property offshore, the price tag has likely just increased. This will affect any company considering a transfer of IP, including pharma and tech companies which have been frequent IRS targets in the past.
Given this landscape it’s quite right to ask whether any of the carrots are big enough to warrant moving IP to the US. There are ways, of course, of moving IP into the US that potentially don’t trigger some of the unintended consequences like the BEAT. It may be possible to temporarily locate IP to the US, thus reducing or limiting outbound payments that could trigger a BEAT liability. But ultimately, businesses will need to have a built-in exit strategy, because if the legislation changes and the corporate rate goes up, it could be expensive to get that IP back out of the US.
But whether companies win or lose from the new rules depends on existing operating structures and the nature and quantity of touchpoints with the US. The winners and losers are not always obvious - and the impact can vary considerably for what are, at first glance, very similar organisations.
While companies making profits in the US are, on the face of it, in a better position, there are additional state tax considerations. States are not bound to follow all the federal reforms. That said, taxpayers may be able to get additional benefits by optimising where in the US they create substance and IP.
This new tax environment is dynamic. There is a real concern that what Congress has done is put in place a tax bill that it can’t pay for.
There is major concern that some of the carrots phase out over time, such as the ability to expense your capital equipment purchases, which will end in five years. The FDII carrot gets less attractive as preferential rates increase in later years. Assets moved to or developed in the US could be trapped when the environment becomes less favourable.
The level of growth that is intended to finance the cuts is extremely optimistic. How do we know that, in a couple of years, Congress won’t return to the reform and eliminate some of the carrots entirely to reduce the likely deficit? Some of the current pieces in the reform could well be unwound.
The new US tax landscape is challenging old assumptions. What was a tax efficient, tax optimal supply chain a year ago may no longer be the best solution.
This is the perfect time for businesses to review their value chain, particularly when adding BEPS into the mix, and to think carefully and holistically about what is optimal in this new environment.
To do that requires a detailed assessment of each and every area of the new US tax system. There is a need to consider cost-benefit, timing and potential foreign/WTO challenges and there is a need to remain flexible in this dynamic environment.
Ultimately, if the net benefits aren’t compelling in the first five years, changing structures purely to derive benefits from the reform is unlikely to be a winning strategy in the long term. Now, more than ever, structural changes should reflect business as well as tax objectives.
Talk to our experts to identify and unpick these issues and get yourself in a position to fully benefit from US Tax Reform.