Foreign companies running a certain type of operation in the US received some unexpected good news this summer from a US Tax Court ruling. Grecian Magnesite Mining Co v Commissioner was a complicated case, but the finding boils down to this: a foreign company which acquired a US company in a partnership structure is not necessarily subject to US taxes.
The ruling could well change how overseas firms book profits on these types of structures, provided, that is, that the Internal Revenue Service does not challenge the ruling. If it does, experts are divided as to whether the Tax Court’s initial ruling will stand.
“This decision is so out of the blue and unexpected, it is impossible to say how it could turn out,” says Phil Zukowsky, a partner in law firm Dinsmore & Shohl’s corporate department. “It overturns a lot of tax thinking about how partnerships and flow-through entities are to be evaluated.”
Made an example
So much for foreign tax planning then, at least in the medium term, in the US. When the case is settled, foreign companies will get the final word on how to structure a partnership for maximum tax efficiency. Until then, however, Grecian Magnesite Mining is the perfect illustration of foreign companies’ plight as they try to parse what is happening with the US tax regime.
Simply put, there are a number of moving parts in play that could well reconfigure tax planning for the country, this case being just one. Another is the practice of inversion, in which a US company merges with a foreign company and reincorporates overseas to lower its tax burden. Last year, the Obama administration tried to crack down on these structures, and a federal court in Texas recently ruled that the administration acted unlawfully. How the Trump administration will react remains to be seen, although it should be noted that this administration is reliably anti-regulation. Likewise, there are developments that could affect US companies active in overseas markets.
How these issues unfold is almost immaterial compared with the current state of uncertainty for investors.
“For any investor, uncertainty is your enemy,” says Stuart Gibson of law firm Schiff Hardin, who also spent nearly 30 years as a senior litigator in the tax division of the US Department of Justice. “Risk is your enemy because how can you make long-term investment decisions if you can’t reliably predict such things as what the tax policy will be?” he says.
Numbers get serious
Perhaps the biggest unknown is the framework for a new tax regime that Republicans in Congress and the Trump administration rolled out in September. It is sparse on details but what it does contain points to significant change for global business tax planners: a 20% corporate tax rate, a 25% rate for pass-through businesses and the elimination of some business deductions and industry-specific incentives. Most significantly, there is a one-time repatriation tax, which could be as low as 10% to entice US businesses to bring back home their foreign earnings, estimated to be between $2500bn and $3000bn.
Just those few sentences – the framework itself is only 12 pages long, including changes for personal taxes – introduce a number of possible scenarios to consider.
To begin with, a lower corporate tax rate could increase foreign companies’ investment in the US. Depending on the rate – and 20% is by no means a forgone conclusion – foreign companies might also be inclined to invest in the US with an eye towards targeting Latin American countries, says John Forry, managing director at accounting and professional services firm CBIZ MHM.
“If they are able to figure out a tax structure that can minimise foreign taxes then there is a tremendous advantage to using the US,” he says.
US companies that have parked their foreign earnings overseas, meanwhile, are no doubt modelling the various scenarios for repatriation, including whether they might get a better result repatriating earnings before tax reform takes effect, says Joe Calianno, international technical tax practice leader at law firm BDO.
“For instance, if they have earnings in a subsidiary that’s in a high-tax jurisdiction, if they were to distribute those earnings, they’d be able to take a lot of foreign tax credits,” he says. It is clear that the US is inching its way to a territorial-based tax regime, although the timing for when that could happen is unclear. But there is movement in that direction and companies are taking that into account as they evaluate restructuring operations, says Mr Calianno.
There are some unwelcome possibilities to consider as well, such as the elimination of the interest expense deduction.
“Obviously the impact of that, particularly for foreign-based investments, is an increase in the cost of operations,” says Don Reiser, managing director at CBIZ MHM. Most foreign companies that set up US subsidiaries do so with some equity in the mix and are able to get the benefit of the interest deduction, says Mr Reiser. Without it, the cost of their capital will increase.
“On the other hand you have to weigh losing that deduction against the fact that US corporate tax rates are going to be reduced,” he adds. By how much, though, no one knows.
It is also possible that the treatment of capital equipment expensing will change. This is a key area of concern for foreign and domestic manufacturers, says BDO international tax services partner and national practice leader Monika Loving. “Possible proposals around expensing and the treatment of depreciation on capital expenditures is a very hot topic of interest for this group,” she says.
What is clear from the framework document is that US lawmakers’ goal is to make the US a more attractive market in which to operate.
Even the discussion around the normally contentious subject of inversions – lawmakers tend to see it as unpatriotic when companies leave the US – is starting to reflect that theme. “There is this new notion that the best way to stop inversions is to make it easier for US companies to stay in the US rather than making it harder for them to leave,” says Schiff Hardin’s Mr Gibson.