Donald Trump’s new tax reform law has triggered the largest corporate tax reduction in US history, reducing the corporate rate from 35 per cent to 21 per cent. Individual rates have also been modified and simplified, however not everyone will pay less taxes on an individual basis and the individual changes will phase out over time, ending after seven years.
The Bill also included a repeal of the individual healthcare mandate which imposed a tax penalty on individuals who do not have health insurance. There are a number of major structural changes relating to trade and overseas investing as well as effects on overseas companies with US subsidiaries.
The reforms were passed in the House and Senate with no Democratic support. The reason for the sunset clause in the individual rates, and a change in the name of the Bill, was so that the Bill could be passed under a “Budget Reconciliation” loophole with a simple 51 vote majority; 51 out of 100 Senators actually voted for the Bill.
Trumps’s new tax reform law has triggered the largest corporate tax reduction in US history
Under regular Senate order, 60 votes would have been required to start debate and avoid a filibuster. According to the Washington Post, West Virginia Senator, Joe Manchin, had indicated that he and other centrist Democrats would have been open to supporting the Bill if the corporate rate reduction was limited to 25 per cent and the difference used to underwrite bigger middle class tax cuts. However negotiations did not get beyond the preliminary stage. Support of centrist Democrats may have been sufficient to make all of the changes permanent and would likely have generated greater popular support.
Given that the Bill was passed without significant debate and the time for in-depth analysis was relatively limited, it is anticipated that there will be relatively significant technical corrections as potential unintended consequences of specific changes become clear. Further definition will also be provided as regulations are announced.
The Bill contains a number of provisions which impact overseas subsidiaries of US companies and also US based subsidiaries of companies headquartered in other countries. The main goal appears to encourage repatriation of significant amounts of capital held overseas by US corporations so as not to incur US taxation.
Another aim appears to be to help blunt the high volume of “inversions” that have occurred over the past number of years whereby US companies have undergone reverse mergers with smaller overseas firms and moved the HQ from the US to lower tax jurisdictions.
The main provisions include:
- A one-time tax at reduced rates for US shareholders on all untaxed foreign earnings since 1986 of controlled foreign corporations (CFCs) in a “deemed” repatriation of those earnings. Earnings currently held as cash, and equivalents, will be taxed at 15.5 per cent and amounts otherwise invested will be taxed at eight per cent. The tax will apply to from 1986 to November 9, 2017 or December 31, 2017, whichever is higher. The tax can be paid over eight years, with payments of eight per cent of the total obligation in each of years 1-5, 15 per cent in Year six; 20 per cent in year seven and 25 per cent in Year eight. Taxable income from a shareholding in one company may be offset by pro-rata losses from a shareholding in another. As a poison pill to discourage inversions, if US company undergoes an inversion over the next 10 years they are liable for 35 per cent tax on the full deemed repatriated amount.
- A scheme which began on January 1 under which dividends received by a US Corporation from overseas corporations in which it has a 10 per cent or greater shareholding will mostly be tax free. This strictly applies to dividends.
- A new tax called the “BEAT” (Base Erosion and Anti Abuse Tax) which limits a company’s ability to move funds off-shore. The BEAT has similarities to the individual Alternative Minimum Tax (“AMT”). It imposes a minimum corporate tax after adding back “base erosion payments” to taxable income. Base erosion payments are deductible payments to foreign affiliates, some payments for services, and certain derivative obligations. The BEAT tax is the difference between the standard company’s tax liability and a minimum tax rate applied to taxable income after adding back base erosion payments. The minimum BEAT rates are five per cent in 2018, 10 per cent for 2019 -2025, and 12.5 per cent thereafter. There is a higher rate for certain financial institutions; six per cent in 2018, 11 per cent for 2019 -2025, and 13.5 per cent thereafter.
- An effort to dilute the appeal of low tax jurisdictions which will see a new tax on Global Intangible Low Taxed Income (“GILTI”, no pun apparently intended on the acronym!). Companies may exclude 50 per cent of applicable income until 2025 and 37.5 per cent thereafter. Up to 80 per cent of local income taxes paid can offset the US tax obligation.
- Encouragement to repatriate offshore assets and encourage export. This sees a new reduced 13.125 per cent tax rate for a US company’s “foreign-derived intangible income,” which is income generated by services provided and goods sold by a US company for use overseas.
- Changes to attribution rules for Controlled Foreign Corporations (“CFCs”) that could cause additional reporting requirements for overseas companies with US subsidiaries and possible additional taxes for the US subsidiary. Previously a CFC was defined as an overseas corporation that is directly or indirectly controlled by 10 per cent U.S. shareholders (US Shareholder owning more than 10 per cent who collectively own more than 50 per cent of the foreign corporation’s equity. The tax bill allows for downwards attribution of direct and indirect ownership from foreign persons to U.S. persons which could require certain foreign companies to be treated as CFCs even though less than 50 per cent of the foreign company is directly or indirectly owned by U.S. shareholders, thereby potentially rendering the US subsidiary to be liable for taxes on earnings of overseas affiliates and also to be subject to the BEAT tax. The change also appears to create new reporting requirements for overseas companies with 10 per cent US Shareholders. We anticipate that these provisions will be further clarified with technical corrections as unintended consequences of the initial bill become clear.
Below are some highlights of other changes as they apply to both business and individuals.
Business Highlights – Changes Mostly Permanent
Individual Changes – Mostly Expire on 12/31/20125