The tax overhaul signed into law by president Donald Trump in December will have a major impact on global FDI as it introduces strong incentives for US multinational enterprises (MNEs) to repatriate trillions of dollars of earnings held abroad and, at least partially, invested in productive operations.
US MNEs, which account for almost half of the global stock of foreign direct investment (FDI) and remain, by far and large, the biggest source of global FDI, might end up repatriating as much as $2,000bn, the United Nations Conference on Trade and Development (Unctad) estimates also looking back at the impact of one-off tax breaks on repatriation introduced in 2005.
Much of the expected outflow is “likely” to come from a small group of host economies that US investors have systematically tapped to make the most of their favourable tax rate, Unctad highlights, pointing out that the UK and its offshore territories alone hold about 40% of their liquid assets. On the other hand, developing countries account for one quarter of the US outward stock, but these resources are largely invested in productive assets and therefore not “easily repatriated”, Unctad adds.
The Tax Cuts and Jobs Act reform, one of the main pillars of Donald Trump’s America First vision, now cuts the country’s corporate income tax (CIT) rate to 21% from 35%, even below a 24% OECD average. With a more competitive CIT rate, the new system also shifts the US tax regime to a territorial system, where only earnings produced at home are liable to be taxed, from a worldwide system taxing income produced worldwide. The bill also features a transitional measure treating all the earnings held abroad as repatriated and taxed a favourable rates – 15.5% for earnings held in cash, and 8% for earning held in illiquid assets (real estate, for example).
US MNEs have accumulated earning overseas for years to avoid high tax rates at home. Under the country’s previous fiscal regime, earnings held abroad were treated as deferred tax liabilities that become payable and subject to a 35% corporate income tax (CIT) rate only upon repatriation. This produced an incentive to keep them parked or invested outside the country on a pre-tax basis, and propelled a global quest for tax efficiency by US MNEs that put them in a position to operate in significantly lower global average tax rates than their competitors. General Electric’s profits, for example, used to be taxed at a rate three times lower than the rate applying its direct competitor, Siemens, according to a report published on Fortune magazine in 2011.
Total retained earnings outside the US are estimated to have ballooned to $3,200bn at the end of 2016, Unctad points out. Back in 2005, the Homeland Investment Act (HIA) managed to draw back to the US about two thirds of the earnings held abroad by US MNEs, amounting to about $300bn.
Unctad now expects a similar degree of success, although “the impact will depend on the actions of a relatively small number of very large MNEs that, together, hold the build of overseas cash”, Unctad noted. Five high-tech companies alone (Apple, Microsoft, Cisco, Alphabet and Oracle) together had more than $520bn in cash overseas at the end of 2016. The top 50 overseas cash holders in the S&P 500 index have parked about $925bn of cash outside the US.
Besides, many implementation details are still being worked out, and they will have an impact on its overall reach in terms of earning repatriation. The country’s investment counterpart are not resting on their allures either. China, for example, has approved tax incentives to stimulate MNEs to reinvest their profits locally. And competition on tax rates is heating up now that the US switched to a territorial system. The The Tax Cuts and Jobs Act is a powerful argument backing Trump’s American First vision, but investment partners will not give in and watch US investment flow out of their countries without playing down their own cards.