US Tax Reform and US inbound multinational groups | KPMG | UK

US Tax Reform: What it means for US inbound multinational groups and M&A transactions

US Tax Reform and US inbound multinational groups

If you’re a UK multinational engaged in M&A transactions in the US, this article outlines the relevant provisions and implications of the US tax reform.

1000

Lead Partner, US Tax London, KPMG LLP

KPMG in the U.S.

Contact

Also on KPMG.com

US tax reform has been a long time in the pipeline, but the final bill, H.R. 1 (Pub. L. No. 115-97), was recently signed by President Trump on 22 December 2017. The new law makes fundamental changes to the current US tax system. 

What’s new about US tax reform?

This is the most significant overhaul of the US tax system since the Tax Reform Act of 1986, transitioning the US from a worldwide system of taxation closer to a system of territorial taxation, while also establishing measures to prevent base erosion from the US. However, instead of simplifying the US tax system, the provisions create significant additional complexity. 

The significant changes include, but are not limited to:

  • Permanent reduction in the corporate income tax rate to 21%;
  • Temporary (for a five-year period) 100% expensing on certain qualified capital expenditures;
  • Limiting net business interest expense to 30% of adjusted taxable income (approximately EBITDA until tax years beginning before 1 January 2022 and then EBIT thereafter);
  • Taxing gain or loss from the sale or exchange of a partnership interest on a look-through basis with respect to US trade or business income, as well as a gross proceeds withholding regime implementing such tax;
  • Minimum tax on certain deductible payments made to a non-US affiliate (referred to as ‘base erosion anti-abuse tax’ or ‘BEAT’); 
  • One time tax charge of deemed repatriation of previously untaxed accumulated overseas earnings (referred to as ‘mandatory repatriation’); 
  • 100% deduction for dividends received from 10% owned non-US corporations (referred to as ‘participation exemption’). 

Other significant provisions target cross-border transactions (such as a new special deduction for certain foreign-derived intangible income and a new tax on global intangible low-taxed income). The new law also imposes new limitations on the use of carryforward net operating losses to 80% of taxable income. (These provisions and the extensive provisions affecting individuals will not be discussed in detail here.)

Treasury and the Internal Revenue Service (IRS) have now started to issue regulatory and other guidance, prioritising mandatory repatriation and the net business interest expense limitation. This additional guidance will help taxpayers to comply with the new rules. It is also possible that so-called ‘technical corrections’ legislation will be enacted in the future to modify the new provisions.   

A closer look at the significant provisions and impact on UK multinationals

Reduction in corporate tax rate to 21%

In recent years, the US corporate tax rate of 35% has been the highest in the Organisation for Economic Co-operation and Development (OECD) countries. The new legislation reduces that rate to 21%, effective for tax years beginning after 2017. This reduction will make the US more competitive globally and hopefully boost the overall economy. However, at the same time, the new bill eliminates or restricts certain tax benefits (such as domestic production activities deduction) that previously drove down the effective corporate tax rate for certain corporations. 

The key impact of this will be:

  • Increased investment in the US and re-evaluate the choice-of-entity for expanding US operations.
  • Potentially less need for tax-free transactions, thanks to the lower tax rate.
  • State corporate income taxes possibly becoming more important in comparison to US federal income tax.

Immediate 100% expensing for certain business assets  

The new law provides for immediate and full expensing for qualified property acquired and placed in service after 27 September 2017 and before 2023. This provision provides a phase down, by increments of 20%, of the bonus depreciation percentage for property placed in service from 2023 to 2026. 

Broadly speaking, qualified property is tangible depreciable property with a class life of 20 years or less. The 100% expensing applies to new and used property if it is the taxpayer’s first use. This provision is not applicable to assets used in any business not subject to the new net business interest expense limitation (for example, certain public utilities and electing real estate businesses). 

The key impact of this will be:

  • Immediate expensing may increase the number of taxable transactions. 
  • Increases the incentive for buyers to structure taxable acquisitions as actual or deemed (for example, pursuant to section 338 or a purchase of 100% of the interests in a partnership) asset purchases, particularly for asset-intensive targets.
  • May result in contentious purchase price allocation negotiations.  

Net business interest expense limitation 

The earnings stripping rules under the old section 163(j) have now been amended to disallow a deduction for unrelated or related-party net business interest expense of any taxpayer, measured at the filter level (for example, the partnership versus partner level and consolidated tax return filing level), in excess of 30% of its ‘adjusted taxable income’. This is similar to EBITDA for taxable years beginning after 31 December 2017 and before 1 January 2022 and then similar to EBIT thereafter.

The new rules allow disallowed interest expense to be carried forward indefinitely. The carryover amount would be subject to a limitation under section 382 in the event of an ownership change. The new net business interest expense limitation does not provide any grandfathering for pre-existing debt. 

Certain categories of taxpayers are exempt from the new rules including certain public utilities and taxpayers with average annual gross receipts for a three year period not exceeding $25 million among other requirements. Additionally, real estate and farming businesses can elect out of this limitation.  

The key impact of this will be:

  • The reduced appeal of debt financing for US acquisitions, necessitating the review of existing US group capital structures and requiring the modelling of optimal global debt placement. 

Tax gain on the sale of a partnership interest on a look-through basis

A hot topic in recent years – starting with the IRS issuing Revenue Ruling 91-32  in 1991 – is whether to tax gain on the sale of a partnership interest by a non-US partner. The IRS took the position that the gain realised by a non-US person from the disposition of a partnership interest should, loosely speaking, be treated as effectively connected income (‘ECI’) to the extent that the partnership assets are used or held in a US trade or business. In 2017, the US Tax Court addressed the IRS’s controversial position in the revenue ruling and determined that the non-US partner should not be subject to US federal income tax on the gain realised from the sale or redemption of a US partnership interest (to the extent the gain was not attributable to US real property interests).  

The new law codifies the IRS position in Revenue Ruling 91-32. In addition, the new law requires the buyer of the partnership interest to withhold 10% of the amount realised unless the seller certifies that it is not a non-resident alien individual or non-US corporation. If the buyer fails to withhold the correct amount, the partnership is liable to deduct and withhold from distributions to the buyer an amount equal to the amount it failed to withhold, plus any interest assessed.

The substantive rule imposing an income tax liability is effective for transfers occurring on or after 27 November 2017, but the withholding requirement applies only to transfers occurring on or after 1 January 2018. The withholding requirement is suspended with respect to transfers of interests in publicly traded partnerships.

The key impact of this will be:

  • Non-US partners investing in fund structures, directly or indirectly, through other partnerships in portfolio companies - classified as partnerships engaged in a US trade or business -  will generally be affected. 
  • Buyer should withhold 10% of the amount realized on a sale in all cases unless a non-foreign affidavit and a US tax ID number from the transferor is received from the transferor. 
  • The potential for duplicative withholding obligations where a non-US partnership transfers an interest in a US trade or business partnership, unless certain coordination rules are provided. 

Base Erosion Anti-Abuse Tax (‘BEAT’) 

The new law implements a base-erosion-focused minimum tax on US corporations, with certain deductible ‘base erosion payments’ made to related non-US corporations. The purpose of this provision is to level the playing field between US multinationals and non-US multinationals, by effectively reversing a portion of deductions attributable to payments to non-US related parties. 

A two-prong test applies to determine if the taxpayer is subject to a potential BEAT liability as follows:

(i) whether the US corporation is part of a group with at least $500 million of annual US gross receipts over a three-year averaging period, and 

(ii) whether it has a ‘base erosion percentage’ of 3% or higher for the tax year (2% for certain financial institutions). The ‘base erosion percentage’ is the ratio of the corporation’s ‘base erosion deductions’ to its total allowable tax deductions for the year. Base erosion deductions generally consist of most outbound deductible payments to non-US affiliates including interest, royalties, certain management services fees, and depreciation expense attributable to property purchased from a non-US affiliate. Importantly, they do not include payments treated as cost of goods sold or otherwise as a reduction to gross receipts. The base erosion percentage of any NOL deduction is also treated as a base erosion payment/benefit for these purposes.

Assuming both prongs of the applicability test are satisfied, the BEAT liability for the tax year is

(i) the excess of 10% of the taxpayer’s modified taxable income (i.e., net taxable income increased by adding back base erosion payments/benefits) for the year (5% for 2018 and 12.5% beginning in 2026) over 

(ii) the regular income tax liability reduced by certain tax credits computed on a separate entity basis except for US consolidated groups. (The applicable rates for certain financial institutions may be different.)

This new law introduces new reporting requirements under the existing regime in connection with Form 5472, Information Return of a 25% Foreign-Owned US Corporation or a Foreign Corporation Engaged in a US Trade or Business, to collect information regarding applicable taxpayers’ base erosion payments and increases the reporting regime’s existing penalty from $10,000 to $25,000. 

The key impact of this will be:

  • The need for possible supply chain modifications (such as using unrelated parties) and determining whether additional items may qualify as cost of goods sold or for exceptions applicable to low value services.
  • The potential impact of BEAT in planning for/pricing acquisitions. 

Mandatory Repatriation and Participation Exemption

To facilitate a move towards a territorial system, mandatory repatriation requires that post-1986 untaxed earnings of certain non-US corporations should be subject to a one-time tax, depending on the type of asset (in other words, tax of 15.5% for cash and cash equivalents and 8% for all other assets). This mandatory repatriation applies to a US shareholder (including US corporations, partnerships, trusts, estates, and US individuals) that directly, indirectly, or constructively own 10% or more of the non-US corporation’s voting power. 

This income inclusion is included as part of Subpart F income for the last tax year beginning before 1 January 2018 (i.e., 2017 for calendar-year taxpayers). The tax can be payable over eight years and the US shareholder can choose not to use its net operating losses against the repatriation income to maximise the use of those losses against taxable income subject to the higher 21% tax rate. 

Untaxed earnings of non-US subsidiaries distributed to certain US shareholders after 31 December 2017 should generally be exempt, as long as those earnings are neither Subpart F income nor subject to the new tax on ‘global intangible low-taxed income’. The participation exemption applies to a US corporation that owns at least 10% of the voting power of the non-US corporation not considered a passive foreign investment company – provided that the distribution is not a ‘hybrid dividend’, with respect to which the paying corporation receives a deduction, among other requirements. Additionally, the participation exemption allows certain deemed dividends under section 1248 relating to a portion of a US corporation’s gain from selling the stock of a controlled foreign corporation to be exempt from tax. However, the taxation of non-US earnings invested in US property under section 956 are retained, as are most of the old-laws for taxing a controlled foreign corporation’s earnings under Subpart F. 

The key impact of this will be:

  • Mandatory repatriation computations will be an important item to review during the tax due diligence process. 
  • Analysis and related restructuring with respect to the repatriation of non-US cash.
    • Base line (non-US tax): Identify non-US tax consequences (and potential legal and operational impediments to bringing cash home to US).
  • The appropriate pricing/contractual provisions will need to be determined to allocate tax between buyer and seller because the tax from mandatory repatriation may be spread over eight years.
  • For private equity, funds or fund partners that qualify as US shareholders of the non-US corporations may be subject to inclusions that are required to be reported on tax returns and schedules K-1.
  • In general, there are likely to be practical challenges in verifying the accuracy of the earnings and profits and foreign tax pools associated with mandatory repatriation. 

Anti-inversion rules 

The prior law US anti-inversion rules were complex and punitive. Under the new law, they have been strengthened to further deter inversions. Broadly speaking, the new law requires a recapture in which the US shareholder is denied:

(i) a participation deduction with respect to dividends from certain non-US subsidiaries; 

(ii) the reduced rates under the mandatory repatriation provision (instead the taxable income would be subject to a 35% tax rate), and 

(iii) the ability to offset the additional US federal income tax imposed by these rules with foreign tax credits. 

This recapture occurs if a US shareholder becomes an ‘expatriated entity’ at any point during the 10-year period following the enactment of this bill. In general, an expatriated entity is when a non-US corporation acquires the stock (or substantially all of the assets) of a US corporation, using its stock as consideration and the former shareholders of the US corporation receive at least 60% of the vote or value of the non-U.S corporation. 

The key impact of this will be:

  • Anti-inversion rules becoming an important item to assess for future merger and acquisition transactions and considerations other than stock may need to be contemplated. 

How can we help?

As we gear up for Treasury and the IRS to issue additional guidance and regulations, KPMG can assist with assessing how the new law will impact your current operations and the operations of US acquisition targets. Supplemental due diligence will be needed to ensure that the target entities are complying with the new laws and correctly assessing the impact of the new legislation on their operations. 

KPMG is able to provide a wide range of services for assisting clients with US tax reform:

(i) Modelling the impact of the new rules on US and global effective tax rate; 

(ii) Performing earnings and profits studies to quantify mandatory repatriation; 

(iii) Performing US debt deductibility and BEAT analysis; 

(iv) Conducting customised workshops to assess the impact on a client’s supply chains and operating model; 

(v) Performing financial statement impact reviews and computations; and

(vi) Considering opportunities to maximise the 100% expensing of qualifying capital investments (such as actual or deemed asset acquisitions). 

 

To find out more, contact Fred Gander, Lead Partner, or Christina Visintainer, Manager, in the US Tax Practice in Europe, KPMG US Tax Services (London) LLP. 

Connect with us

 

Request for proposal

 

Submit