CCH Networks recently hosted a webinar in which respected KPMG tax partner Grant Wardell-Johnson shared insights into US tax reforms enacted in December 2017. These changes will significantly impact not only US businesses and individuals but also the global economy. Grant Wardell-Johnson explores some of the implications for practitioners.
Key US reforms
The following are some of the key US tax reforms (further details and the conditions in relation to each are outlined in the webinar):
- Reduction in the US corporate tax rate from 35% to 21% applying from 1 January 2018.
- Expensing measures that lead to an immediate write off (100% depreciation deduction) of most new and used plant and equipment to encourage business investment.
- Limitation of interest deductions to 30% of EBITDA (currently 50%), consistent with the recommendations of Action Item 4 in the BEPS Action Plan. These rules have a similar policy goal to the Australian thin capitalisation provisions.
- Modification of Net Operating Loss Deduction. The Corporate Alternative Minimum Tax has been repealed. However, in association with this measure most carried back losses are denied and losses can be offset against 80% of taxable income.
- Participation Deduction (Exemption). Certain US corporations can claim a 100% dividend received deduction (DRD) for the foreign sourced component of a dividend. This is subject to a holding period of 365 days in the 731 days before the dividend is paid. The rules also contain an anti-hybrid measure and the DRD is not available to the extent that a dividend is deductible in a foreign jurisdiction. The DRD reduces the cost base of shares that the US company will have in a foreign company for the purposes of a capital loss (not in relation to a capital gain).
- Transitional Tax. There will be a one off mandatory deemed dividend of untaxed earnings and profits held by foreign subsidiaries of US corporations. This applies to specified foreign corporations which are controlled foreign corporations or a non-US corporation with a 10% or more US shareholder (by vote or value). The measure applies to the last tax year beginning before 1/1/2018. The effective rate on the cash portion of the dividend is 15.5% and the non-cash component is 8%.
- GILTI This measure is an extension of the US CFC rules, designed to ensure that a US shareholder is taxed on global intangible low taxed income. Broadly, GILTI is income that exceeds a deemed tangible asset income return of 10%. This income will be included in the US shareholder’s income. However, it may be offset by an additional deduction for foreign derived intangible income (“FDII”) at a rate of 37.5% reducing the effective tax rate on intangible income to 13.125%.
- BEAT. Broadly this measure looks at base erosion payments which includes all deductible payments (apart from cost of goods sold) made to foreign related parties. The measure calculates an amount based on the existing liability of an entity, adding base erosion payments less the regular tax liability. If the residual amount exceeds a certain trigger (3% for a normal business) the BEAT is applied.
- Individual Tax Reforms include:
- a reduction of individual tax rates
- the standard deduction has almost been doubled. This operates in a similar way to the Australian tax-free threshold
- repeal of personal exemptions.
- 20% deduction for business income (excluded for certain service trades)
- doubling of child tax credit
- repeal of itemised deductions
- changing of thresholds for deducting mortgage interest
- increase of the alternative minimum tax exemption and a phase out in relation to the exemption.
Some practical implications:
The US tax reforms are complex. Practitioners are still working out how the new measures interact with existing legislation and identifying unintended outcomes or anomalies that may result.
The reduction in the corporate tax rates, expensing measures, FDII, GILTI and BEAT will promote companies relocating activities back to the US. The participation exemption will have a significant treasury impact, promoting cash repatriation to the US. The expensing measures (immediate write off for plant and equipment) may impact M&A transactions that under current rules are allowed to be treated as an asset rather than a share sale. That existing rule and its interaction with the expensing measures may mean that an asset sale is more attractive than a share sale option.
New calculations in relation to the mandatory Transitional Tax will be required (eg practitioners with Australian subsidiaries of US corporations). Likewise, this tax has complex recapture rules designed to deter inversions. In light of a tightening of thin capitalisation rules, inbound investors (eg Australian entities with subsidiaries in the US) should consider that financing into the US may require a lower gearing.
The taxing landscape in the US has substantially changed for multinationals. Consequently, advisors will need to carefully consider any current structures that are in place in relation to the location of certain functions, dividend, cash and treasury policies.
Reductions in the US corporate tax rate (and global corporate tax rates) may increase pressure to further reduce the Australian corporate tax rate. This may also lead to a view that Australia’s existing corporate tax rate is uncompetitive.
How recent US tax reforms fit into the big picture
In recent times the overall environment in relation to international tax rules appears to be changing. There is a gradual shift from promoting additional cohesiveness and multilateral action, evidenced by strong treaty networks and the Base Erosion and Profit Shifting(“BEPS”) agenda to a focus on unilateral responses in international taxation rules. Unilateral actions by countries include measures such as the UK Diverted Profits Tax, the Australian Multinational Anti-Avoidance Law and Diverted Profits Tax and the Indian Equalisation Levy. The US tax reforms are an example of extending this type of unilateral action particularly in relation to measures such as the US Base Erosion and Anti-Abuse Tax (“BEAT”) and Global Intangible Low Taxed Income (“GILTI”). The overarching goal of these measures are to promote activity and property ownership being located in the US.
Click here for the CCH Networks webinar “Implications of US Tax Reforms in Australia”, 30 January 2018.