As 2017 wound to a close and the US legislative system slogged its way to a revamp of its tax code, Israeli finance minister Moshe Kahlon voiced a thought: with the US on track to pass a corporate tax rate of 21%, Israel may have to adjust its own rate. As expected, the US law passed at the end of the year and by early January, Israeli prime minister Benjamin Netanyahu had set up a panel to study its implications and its effect on Israel’s competitiveness.
Expect this scenario to play out in government offices and corporate boardrooms across the world well into 2018. To say the new US law – called the Tax Cuts and Jobs Act – is a sweeping change for all involved is an understatement.
A competitive nation
US companies will be making major changes, such as the repatriation of cash back into the US and the restructuring of their global intellectual property operations. Everything is fair game for change, from physical operations to IT to the movement of people.
As for other global governments, they were given a wake-up call on December 22, 2017, when the US tax reform was signed into law, according to Nicole Suk, international tax practice lead at Windham Brannon in Atlanta. “No longer do they preside over the lowest tax jurisdictions of the world,” she says.
The crux of the new law reduced the US corporate tax rate from 35% to 21%, a change that could upend global direct investment patterns, as Israel is keenly aware.
Other countries are also concerned. The EU, and in particular Germany, is worried about losing manufacturing to the US now, according to Ms Suk. “With both the US and Germany having skilled workers in the manufacturing arena, but with Germany always being able to edge out the US on manufacturing investment because of a lower tax rates, German economists are now concerned that significant amounts of new investment and jobs will shift from Europe to the US,” she says.
Mexico, to cite another example, has also become less competitive, according to Stephanie Yarbrough, partner at US law firm Womble Bond Dickinson. Many projects are already competitive with Mexico, and the lowering of the US tax rate could prove to be a tipping point when compared with Mexico’s corporate rate of 30%, she adds.
A quasi-territorial tax system
Perhaps even more significant is that the tax law heralds the US’s shift to a quasi-territorial system for domestic companies, according to Carlos Somoza, who leads the Kaufman Rossin International Tax group in Miami. It means a domestic company will no longer be subject to US income tax on profits from operations outside the US. And, says Joseph Calianno, international technical tax practice leader at global accounting network BDO, “lawmakers are hoping that this provision will stimulate the US economy” with the repatriation of offshore profits.
To balance the country’s books, Congress also imposed a transition tax on accumulated foreign earnings and profits generated by foreign operations owned by US companies. “This transition tax, which is 15.5% of a foreign corporation’s earnings and profits associated with cash assets or 8% for all other earnings and profits, is triggered regardless of whether the foreign corporation in question actually distributed funds to the US taxpayer/owner,” says Mr Somoza.
A new category of income
The act also introduces a new category of income: global intangible low taxed income (Gilti). This ensures US companies pay a minimum amount of US tax on the income generated by 'controlled foreign corporations'. “Domestic corporations are provided with a deduction that results in Gilti income being taxed at an effective tax rate of approximately 13%,” says Mr Somoza.
Gilti requires US companies to pay tax on low-taxed income, regardless of whether it is portable, according to Ryan Dudley of New York City-based Friedman. “As a result, the opportunity to derive low- or no-tax income offshore and keep that benefit by deferring the repatriation of profits to the US, is gone,” he adds. “While the effective tax rate on income for US corporations may be reduced by a special 50% deduction, this income will be now be taxed to some extent either offshore or in the US.”
In other words, US companies no longer have an incentive to move their intangible assets and income-producing functions offshore anymore. Gilti will also affect transfer-pricing planning by allocating profits and expenses to the US, says Jessica Silbering-Meyer, managing editor, international tax, at Thomson Reuters’ tax and accounting business.
There are also several provisions in the new law that target base erosion, according to Mr Calianno. One provision – the base erosion and anti-abuse tax – adds an additional corporate level tax on corporations that make deductible payments to foreign-related parties. This provision could impact many US companies that are part of foreign-based multinational groups, he adds.
A complicated law
The law is complicated, generally retaining the existing US international tax system while layering on additional provisions, according to Taylor Kiessig, a partner in law firm Eversheds Sutherland's US tax practice. For example, even though the US is switching to a quasi-territorial tax system, Subpart F rules – which eliminate the deferral of US tax on some categories of foreign income – remain in effect.
Still, the overarching effect of the law and its many provisions is that the complex offshore arrangements that US companies had in place to take advantage of tax deferral and avoid Subpart F rules may no longer be an attractive strategy for multinationals, according to Ms Silbering-Meyer.
And as for foreign companies investing the US, they previously attempted to have as small a footprint as possible to minimise corporate tax exposure, says Mr Dudley, adding: “In many cases, this is now reversed.”