Since the enactment of the Tax Cuts and Jobs Act (TCJA) signed into law on Dec. 22, 2017, U.S. companies are continuing to analyze the impact of the largest American tax reform in decades. With a substantial amount of additional guidance and, possibly, amendments expected over the upcoming months, foreign multinationals, too, must consider how reform provisions will affect their U.S. footprint and how their inbound structures of investment in the U.S. should evolve to address the impact of tax reform and to create tax efficiency going forward. Below is a brief highlight of the top 10 tax reform items that are likely to have the most meaningful impact on the U.S. operations of foreign multinationals.
- Federal corporate tax rate. The TCJA permanently reduces the top U.S. federal corporate rate to 21 percent from 35 percent effective for the tax year 2018. In the case of fiscal year filers, a blended rate will apply to tax years that straddle Jan. 1, 2018.
Note: There have been rumors about future tax rate increases by certain states. States corporate tax rates currently range between 5 percent and 12 percent. Although no changes have been enacted at this stage, this is an area to watch closely.
- Interest expense deduction. The existing “earning stripping” rules, limiting the deductibility of certain interest payments to foreign related parties, are being expanded. Prospectively, the deduction for net interest expense, whether paid to a related party or not, will be generally limited to 30 percent of the taxable income of the U.S. business, modified by adding back deductions for business interest, non-business items and—for taxable years beginning before Jan. 1, 2022—depreciation and amortization.
Note: Certain companies are exempted from the interest limitation rules, including businesses with average annual gross receipts of $25 million or less and real property trade or businesses.
- Net operating losses. The TCJA generally repeals the net operating loss (NOL) carryback election but permits an indefinite carryforward of NOLs. However, the amount of a NOL carryover that is deductible in any taxable year is limited to 80 percent of that year’s taxable income.
Note: The new rules apply to NOL sustained in 2018 or later years. Pre-2018 NOLs will continue to be subject to pre-TCJA rules and available to offset 100 percent of the taxable income in 2018 or later years.
- Capital expenditures. For the next few years, U.S. companies will be able to lower their effective tax rate through accelerated recovery of capital expenditures. The new provision allows for full expensing (100 percent) of the cost of “qualified property” placed in service within the next five years (six years for certain property with longer production periods).
Note: The new 100 percent expensing regime exceeds the pre-TCJA accelerated recovery programs that are limited to a maximum expensing amount per year or to 50 percent of the asset acquisition costs.
- Base erosion minimum tax. The TCJA implements a new base erosion anti-abuse tax (BEAT). Large U.S. corporations and U.S. branches of foreign companies with average annual gross receipts of at least $500 million for the prior three-year period may be subject to the BEAT if they have substantial “base erosion payments.” Generally, these payments include any amount paid or accrued to a related foreign person, but excluding payments for cost of goods sold.
Note: In simplified terms, in 2018 affected taxpayers will be subject to a 5 percent tax calculated on an adjusted taxable income base that adds back base erosion payments, if such tax exceeds the regular tax. The BEAT rate is due to increase to 10 percent in 2019 and 12.5 percent in 2026.
- Disallowance of deduction for hybrid payments. Certain hybrid payments of interest and royalties made to foreign affiliates are now disallowed as deductions from the U.S. taxable base when the foreign affiliate is not required to recognize income for such payment under the tax laws of its country of residence.
- Participation exemption regime. Effective for the year 2018, dividends received by U.S. corporations from their non-U.S. subsidiaries will be entitled to a dividends received decuction, effectively exempting foreign source dividends from U.S. tax, granted certain requirements are met. Thus, the U.S. may now be a more attractive jurisdiction to also hold foreign corporations.
- Repeal of domestic production activities deduction. The section 199 domestic production activities deduction (DPAD) is repealed effective in 2018. In prior years the DPAD provided a substantial benefit to U.S. manufacturer in the form of a deduction up to 9 percent of certain domestic production activity income.
- Export and intellectual property (IP) incentive regime. The TCJA introduces a new low-tax regime applicable to foreign-derived intangibles income (FDII). U.S. corporations with substantial sales of products and services outside of the country may benefit from a new deduction scheme intended to bring the effective federal tax rate on qualifying foreign-derived income down to approximately 13 percent (16 percent starting in 2026).
Note: Despite its name, the FDII deduction is intended to benefit a large spectrum of U.S. companies selling products and services abroad, including other revenue streams besides royalty or IP-related streams.
- Amortization of research and experimental expenditures. Starting in 2022, U.S. companies will be required to capitalize their research or experimental outlays, including the costs attributable to software development, and recover the expenditure through tax amortization over five years. Currently, and until 2021, a tax deduction can be claimed in the same year the research or experimental expenditures are incurred.
Note: Regardless of the change in the timing of the deduction, qualifying the research or experimental expenditures will continue to be eligible for research and development (R&D) tax credits.
Source: Baker Tilly Virchow Krause
US inbound insight - March 2018