The much talked-about United States tax reforms are finally enacted with President Donald Trump signing on the historic bill on December 22, 2017. This tax reform legislation could be touted as one of the quickest in the recent times.
As discussed in our earlier article, there were considerable differences between the House version of the tax reforms and the Senate version. Both houses have been able to resolve their differences swiftly to come out with the final tax reforms Act. The notable changes in the final version are discussed below.
Tax Rate Cut
Both the houses have agreed to reduce the corporate tax rate to 21 percent with effect from tax years beginning from January 1, 2018, onward instead of 20 percent proposed earlier.
A 14 percent reduction from the existing headline corporate tax rate of 35 percent is the most significant reform measure creating ripples around the globe. The U.S. expects that the loss of tax revenue will be made good by increasing the tax base as many businesses are expected to move their operations to the US. A case in point to fathom the potential impact of the change is the budget resolution which provided that the tax loss due to the tax reforms bill cannot exceed $1.50 trillion over a 10-year period.
It is important to note that the lower rate of 21 percent will apply from January 1, 2018, for taxpayers whose tax year starts on January 1, 2018. For other taxpayers, it will apply from the tax year which starts after January 1, 2018. For instance, if the tax year starts from April 1, 2018, the rate of 21 percent shall apply from April 1, onward.
The taxable income earned during January to March 2018 will continue to be taxed at the existing rate of 35 percent.
Abolishing AMT
The House version recommended abolishing the Alternate Minimum Tax (AMT) on corporates whereas the Senate version was silent on it. In the final version, the House has prevailed. The final version of the Act provides for the complete abolition of the corporate AMT.
Taxpayers with existing AMT credits can carry them forward for next four years (up to 2021). There is also a proposal to claim a refund of 50 percent of the AMT credit, subject to conditions.
Migration To A Territorial Tax System
The House and the Senate had fairly agreed on these measures in their respective versions. U.S.-based corporations will now have a territorial tax system where profits earned by specified 10 percent-owned overseas entities will not be taxed in the U.S.
Thus, all dividends repatriation by U.S. subsidiaries back to the U.S. would be effectively tax exempt.
These measures will be applicable on all “active” business earnings and dividends earned after 2017. One would, of course, have to look at what constitutes “active” business income.
Deemed Profit Repatriation Tax
The one-time deemed profit repatriation tax remains and will be charged at 8 percent on illiquid assets and 15.5 percent on liquid assets, which marks an approximate 1 percent increase over the rates proposed in the House Bill (7 percent and 14 percent) and the Senate Bill (7.5 percent and 14.5 percent). A partial underlying tax credit would be available. Further, the taxpayer will have the option of deferring the payment of tax over a period of 8 years as was originally proposed.
From a calculation perspective and as an anti-abuse measure, the base for calculating the deemed profit repatriation tax will be: the earnings and profit amount as on November 2, 2017, or as on December 31, 2017, whichever is higher.
Thus, any reductions in the earnings and profits (or conversion from liquid assets to illiquid assets) between November 2, 2017, and December 31, 2017, will not affect the tax liability.
Anti-Abuse Tax On Overseas Payments
This was one of the most widely debated reform measures. The House and the Senate, in principle, agreed on enacting a legislative tax deterrent to outsourcing and migration of operations outside the U.S.
The House proposed an Excise Tax @ 20 percent on all payments, other than interest, made by a U.S. entity to overseas related entities, with a minimum threshold of $100 million per year. On the other hand, the Senate proposed a 10 percent Base Erosion and Anti Abuse Tax (BEAT) on certain payments, including interest, to overseas related parties if the payments exceed 50 percent of the taxable income of the US entity.
In the tussle between the Excise Tax and BEAT, the BEAT has won and finds a place in the final Act.
The Excise Tax has been dropped. The BEAT will apply to companies where the group turnover exceeds $500 million, calculated as an average of the last three years. It also proposes a threshold based on the ratio of deductible payments to the taxable income of the U.S. entity (Base Erosion percentage). Most importantly, BEAT does not apply to payments for the cost of goods sold (other than inverted corporations).
Broadly, the BEAT will be the excess of 10 percent of modified taxable income over the regular tax liability of the taxpayer. While as a concept, the BEAT may be comprehended, its application in practice is expected to be challenging. The BEAT provisions are contained in more than 20 pages and there are multi-step formulae to calculate BEAT. Hence, evaluation of the impact of BEAT on business strategies would require a detailed examination.
Limiting Interest Deduction
The Act includes a new limitation of business interest provision. The business interest deduction shall be limited to 30 percent of operating EBITDA (derived through certain specified adjustments). Post-2021, it appears that the deduction will be calculated based on EBIT.
As a relief measure to small taxpayers, these provisions shall apply only where the gross receipts of a taxpayer exceed $25 million, calculated as an average of the past three years.
These provisions would equally apply to existing debt in the capital structures of a U.S. entity i.e. there is no grandfathering provided for existing debt investments. Further, the House Bill and the Senate Bill provided for limiting the interest deduction after taking into account the U.S. entity’s contribution to the net interest of the group as well as its contribution to the worldwide EBITDA. The final Act does not contain such provisions.
Favourable Tax Regime On Foreign-Derived Intangibles Income
In what appears to be the U.S. version of a patent-box, the final draft of tax reforms proposes a concessional tax rate regime for foreign-derived income from intangibles. The final Act proposes a deduction/exemption of 37.5 percent on such income earned.
The corporate tax rate of 21 percent will apply on the income after this deduction, resulting in an effective tax rate of 13.125 percent of the income earned.
Overall, the U.S. tax reform proposals run over 1,000 pages and provide for complex structural modifications to the existing complex U.S. tax laws. Taxpayers need to evaluate the impact of the tax reforms on a holistic basis and should refrain from taking a myopic view of a particular reform measure. The impact of the reforms could vary from country to country and taxpayer to taxpayer. The impact also depends on how the world reacts to the U.S. tax reforms and how the interplay of different macro-economics forces plays out in the near future.
Maulik Doshi is a partner and Chetan Daga is a senior manager at SKP Business Consulting LLP.
The views expressed here are those of the authors’ and do not necessarily represent the views of Bloomberg Quint or its editorial team.