By Maulik Doshi & Chetan Daga
Forget BEPS, GAAR and GST — The TCJA (The Tax Cuts and Jobs Act) is the new acronym that’s trending now in the tax world! The United States of America is on the verge of finalising path-breaking tax reforms. The reform measures — which attracted significant cynicism, particularly about the time frame of their implementation — are soon going to become a reality.
As things stand today, certain differences need to be reconciled between the bill passed by the House of Representatives (House Bill) and the Bill passed by the Senate (Senate Bill). The House and the Senate have agreed to a majority of the reforms, in principle, and given the speed at which this has moved in the last few weeks, the passage of the tax reforms seems to be a reality before Christmas. The new tax law will come into effect from Jan. 1, 2018 or Jan. 1, 2019 depending on the version (House or Senate) that is incorporated in final bill. The changes proposed are radical and would have implications across the globe — including in India — and present both an opportunity as well as challenges to multinational corporations looking at their tax costs.
Tax rate cut
The U.S. tax reform proposes to significantly reduce the existing corporate tax rates from 35 percent to 20 percent (or 22 percent as suggested by some quarters). While President Trump couldn’t achieve his target of 15 percent corporate tax rate, the 20 percent tax rate would catapult U.S. as one of the most attractive investment destination with competitive tax structure. This would prompt many MNCs to relocate their operations back to the U.S. which is the basic intention behind the tax reforms.
U.S. MNCs operating in India would start to relook at the profits that are made in India as the higher tax rate in India would add to their tax burden.
This could also see significant changes in the transfer pricing policies adopted by U.S. MNCs in remunerating the Indian subsidiaries. Similarly, for Indian MNCs operating in U.S. — especially in the information technology space, would want to keep more profits in the U.S. rather than in India, to minimise the overall tax burden and use those profits to expand globally. Reduction in the U.S. corporate tax rates may also prompt other countries, including India, to look at their domestic tax rates to retain their competitive positions in the world, obviously balancing this with the need to rein in the fiscal deficit.
No tax on overseas profits
More than the tax rate cut, the proposal to move to a territorial system of taxation would shake the economies. Presently, U.S. follows global basis of taxation i.e. profit earned by overseas entities remitted back to the U.S. is taxed in U.S.. This prompted many notable U.S. corporations to create complex structures and retain profits outside the U.S. As a part of the tax reforms, the U.S. will move to a territorial tax system (more of a destination-based tax system) where profits earned by overseas entities from overseas operations will not be taxed in the U.S. i.e. 100 percent exemption for overseas profits distributed as dividends.
As a transitionary measure, the U.S. proposes to impose a deemed profit repatriation tax.
In simple terms, the U.S. will compulsorily — as a one-time measure — tax profits retained overseas at a concessional tax rate of 7 percent to 14.5 percent, depending on the nature of assets (liquid/illiquid) in which the overseas profits are presently retained. Taxpayers are also provided an option to pay this tax in equal installments over an eight-year period.
The deemed profit repatriation tax could see a substantial move of capital from overseas entities to the U.S. entity, as the tax reasons for retaining profits overseas no longer remain. This could make a significant cash pool available to U.S. entities and among other things, the treasury management and investment functions could become more prominent.
Anti-abuse tax on overseas payments
For all those who are wondering where the money will come from to fund the largesse, the answer lies with an introduction of Excise Tax (under the House version) or Base Erosion and Anti Abuse Tax (BEAT) (under the Senate version).
While both House and Senate differ significantly on the rate and mode of the levy, essentially this proposal will tax payments made by U.S. companies to their overseas affiliates.
As per the House Bill, there would be an excise tax of 20 percent on all payments, other than interest, made by a US entity to overseas related entities. This provision will apply only to payments above a particular threshold, which currently appears to be $100 million per year. The Senate Bill proposes a 10 percent minimum tax on certain payments (which includes interest) to overseas related parties if the payments exceed 50 percent of the taxable income of the U.S. entity. Also, it seems that the Excise Tax or BEAT levied in the U.S. would not available as a credit in the other country and hence would be more like an additional tax cost.
This change would significantly affect India and reduce the cost arbitrage it currently presents, especially in the IT and pharmaceutical industry, where a significant amount of back-office or research and development work is outsourced to India. This would also affect U.S. companies that have contract manufacturing operations in India or China and would increase their costs of operating globally.
Limitation on interest deduction
The tax reforms propose to introduce provisions to limit the deduction of interest paid by a U.S. entity. Again, depending on which version of the bill gets finally enacted, this could seriously impair Indian MNCs’ expansion plans in U.S. and their funding pattern.
There are several other provisions, like those dealing with the carry-forward of net operating losses, repeal of Alternative Minimum Tax, higher depreciation and expensing certain the capital purchases, reduction in effective taxes for pass-through which are all also relevant.
At an overall level, apart from the creation as well as the elimination of tax efficiencies and arbitrages, the U.S. tax reforms are bound to result in significant modifications to the existing business models. The business valuation of U.S. entities could also undergo a significant change based on a complex interplay of different reform measures. All in all, the U.S. tax reforms could necessitate a relook at existing tax structures and policies, well in time!
Stay updated with all the insights.
Navigate news, 1 email day.
Subscribe to Qrius