Five minutes on… the major US tax reforms

America’s new tax law was passed amid heated wrangling over its final text. Now that the dust has settled, what does it mean for corporates?

Following chaotic scenes at the US Senate in the run-up to Christmas last year, the Tax Cuts and Jobs Act 2017 – known for short as the licence plate-friendly HR 1 – was signed into law on 22 December.

One of the most remarkable aspects of the legislation was the sheer haste with which it was crammed on to America’s statute.

It was unusual enough that the Act’s sponsors kept its full text out of the public domain for much of the partisan debate that raged over its meaning.

On top of that, though, it emerged that during one, critical phase of the debate the text had been edited and amendedby hand.

Given those bumpy, unorthodox origins, corporate stakeholders could be forgiven for desiring a measure of clarity on what sort of impacts the Act holds for them.

Key points for corporates

How fortunate, then, that we have an impartial analysis from US scrutineers the Joint Committee on Taxation (JCT) to refer to.

In the JCT’s considered view, the Act’s primary effects on corporates are that it:

  1. lowers the corporate income tax rate from 35% to 21%;
  2. increases the rate of bonus depreciation to 100% this year, which is extended for five years up to 2022 and then phased out by the end of 2026;
  3. repeals or limits deductions for a number of business expenses – the largest of which are a 30% limit on interest deductibility, and a denial of carryback treatment of the net operating loss (NOL) deduction; and
  4. allows domestic corporations to receive a dividend from their foreign subsidiaries without incurring US tax on the income – effectively switching the US corporation tax framework from a worldwide system to a territorial one.

Further to that third point, the JCT adds: “In order to reduce the erosion of the US corporate income tax base, the bill equalises the tax treatment of high return income from foreign sales whether they are earned through a foreign corporation or a domestic corporation, and imposes a new minimum tax for certain related-party transactions.”

Choice-of-entity implications

A separate KPMG analysis of the legislation points out: “The corporate rate reduction … may affect choice-of-entity decisions for some business entities.

“The new law does not distinguish between investment income and business income earned by corporations for purposes of applying the 21% tax rate.

“In addition, even though Senate Finance Committee chairman [Orrin] Hatch had been exploring integrating the corporate and individual income taxes, the new law does not contain a corporate integration proposal – meaning that corporate income is subject to a further tax in the hands of shareholders when distributed to them as dividends.”

With that in mind, KPMG advises: “In making choice-of-entity determinations, taxpayers should consider the reduced corporate rate and the impact of other changes to the Code under the new law, as well as other Code provisions, such as the accumulated earnings and personal holding company taxes.”

Ultimately, the auditor writes, “choice-of-entity decisions will continue to depend on individual facts and circumstances”.

M&A implications

KPMG’s examination of the Act also notes: “The new law changes the definition of qualified property (ie, property eligible for bonus depreciation) by including used property acquired by purchase, so long as the acquiring taxpayer had not previously used the acquired property, and so long as the property is not acquired from a related party.”

While the Act “removes qualified improvement property from the definition of qualified property for bonus-depreciation purposes,” the auditor writes, “such property appears to remain bonus eligible, since it would now have a specified recovery period of 15 years and thus meet the general ’20 years or less recovery period’ requirement for bonus qualification.”

That change in the definition of qualified property, the auditor stresses, could have an “important effect” on M&A deals: “It increases the incentive for buyers to structure taxable acquisitions as actual or deemed asset purchases, rather than stock acquisitions, by enabling the purchasing entity in an asset acquisition to immediately deduct a significant component of the purchase price – and potentially to generate net operating losses in the year of acquisition that could be carried forward to shield future income.”

Adapt to survive

In terms of the core challenge that the Act presents to multinationals, Tim Wach – managing director at global tax-advice network Taxand – says that it will be to digest, and adapt to, the new rules.

“At present,” he notes, “businesses are treading water and struggling for guidance and clarity on what the reforms mean in reality. The bill was passed very quickly, and on a partisan basis, meaning it is not without its issues.”

As HR 1’s measures will be phased in over the next 10 years, Wach argues, “multinationals remain in standby mode, waiting to see what happens with guidance before they act. One thing’s for sure: change and uncertainty is the new norm.”

…but how long will the Act really last?

However, Wach points out: “There are strong arguments to suggest that the bill doesn’t necessarily have staying power – particularly if the Democrats take back control of [Congress] later this year, which could bring tax reform back to a deadlock.

“The economic situation in the US also casts a shadow over the reforms. Given the level of the US federal deficit, a point could come where the party will be over and the music will stop.”

He adds: “With debt already in a worryingly unprecedented territory, at some point in the future the US will have to consider tax increases – unless we see a significant level of economic growth.”

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