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US Tax Reform – what does it mean for Irish treasury operations?

On 22 December 2017, President Trump signed into law in the United States the Tax Cuts and Jobs Act (“TCJA”). The TCJA is an amalgam of two competing tax reform measures - one approved in the House of Representatives and the other approved by the Senate, albeit in a number of ways the final TCJA is more closely aligned to the Senate bill. Most of the measures proposed came into effect from 1 January 2018.

Aside from the headline-grabbing reduction in the Federal corporate income tax rate from 35% to 21%, there were a number of measures that could impact on Irish financing vehicles that are used to fund US operations. This article focuses on three such specific elements of the TCJA, namely:

1.    Limitation of interest deductibility;

2.    Base Erosion Anti Abuse Tax (“BEAT”); and

3.    Global Intangible Low Tax Income (“GILTI”)

Limitation on interest deductibility

Under the TCJA, a deduction for interest incurred by a US borrower is limited to net business interest income plus 30% of adjusted taxable income (“ATI”), which is broadly similar to EBITDA. However, from 2022 onwards, the 30% ATI cap will be computed after depreciation and amortisation (i.e. based broadly on EBIT, which would be a smaller number meaning a greater interest deduction restriction). Where any interest expense is disallowed by virtue of the restriction, it is available to be carried forward indefinitely to future periods.

An important point to note is that even where an amount of interest is deductible, it may still be within scope of BEAT (discussed in the following section).

Also worthy of note is how the interest restrictions under the TCJA compare with those proposed to be introduced under the EU’s Anti-Tax Avoidance Directive (“ATAD”) (due to come into force for Member States between 2019 and 2024). Broadly, ATAD has a similar 30% EBITDA-based cap. However, currently there is no proposal to move to an EBIT-type cap (unlike the US from 2022). The definition of interest under ATAD is somewhat wider than under the TCJA, as it also applies to other financing-type charges such as guarantee fees, finance lease interest and certain derivative gains and losses. That said, this is counterbalanced by a wider range of potential exclusions provided for under ATAD (such as de minimus  tests, group-wide tests and financial undertakings exclusion).

BEAT

The BEAT is essentially a “minimum tax” concept whereby if a US taxpayer’s tax liability is reduced by more than 50% by related party base erosion payments (such as interest), BEAT may impose an additional tax. BEAT applies to deductible amounts paid or accrued to related parties (such as an Irish financing company) in tax years beginning after 31 December 2017. The BEAT is computed by multiplying the Modified Taxable Income (broadly the taxable income excluding related party payments) by 10%  (5% for 2018) and comparing it with the US company’s normal tax liability (after  taking account  of most credits, including foreign tax credits, but not excluding the research and development credit). Any excess of  the modified tax over the  normal tax liability is the BEAT amount due.

Important points to note are that any amounts relating to costs of goods sold, certain prescribed services set out by the IRS (broadly low margin services) and qualified derivative payments may be excluded from BEAT.

Furthermore, BEAT does not take into account how the other party to the transaction (e.g. an Irish financing company) may be taxed. Therefore, it is possible credit may not be available in Ireland for the additional tax suffered (i.e. BEAT) and therefore double taxation might arise.

GILTI

The move by the US to a “territorial” tax regime has resulted in additional tax base protection measures to its existing controlled foreign company (“CFC”) rules, via the minimum tax concept – the GILTI regime. GILTI is broadly the excess income of foreign subsidiaries over a 10% rate of routine return on tangible business assets.  Unlike the limitation on interest deductibility and BEAT which can apply to both US and non-US parented groups, GILTI is only relevant for US parented groups (including non-US parented groups that own non-US shares through a US entity—so called “sandwhich stuctures.”). The tax on GILTI is computed after taking a 50% deduction from GILTI and an 80% credit for any foreign tax suffered (albeit such foreign tax credit is not available for regulated investment companies or REITs).

To illustrate the practical impact of GILTI, the table below sets out a numerical example with the following assumptions (it is simplified somewhat with respect to the treatment of foreign taxes for ease of calculation):

·       Assume a US headquartered group

·       Irish FinCo is an Irish treasury company which taxes interest income at 12.5%

·       Irish FinCo receives interest income of 100 from related group companies.

 

Irish FinCo – GILTI computation

GILTI inclusion

100

Deduction

(50)

Taxable amount

50

 

 

Tax @ 21%

10.5

 

 

Credit for Irish tax (80% of 12.5)

(10)

 

 

US tax under GILTI regime

0.5

 

 

Total tax (US and Ireland)

13

 

 

From the above simple example, there would be no additional US tax if the Irish effective tax rate on GILTI was at least 13.125%. An interesting observation one may take from the above is that if the financing company was located in a jurisdiction that did not tax interest income, a lower total overall tax cost may arise (e.g. GILTI of 10.5 in the US only), but it is likely in such a situation that withholding tax would arise on outbound interest payments to the no-tax jurisdiction to negate any such benefit.

Importantly, the above example ignores the requirement that certain expenses of the U.S. parent be allocated to the GILTI “basket” in order to determine the U.S. foreign tax credit on the Irish income.   While it remains unclear how these expense allocation rules will apply in this context, each $1 of expense allocated to GILTI income under these rules will result in a foreign tax credit reduction of $0.21.   

Comparison of US and non-US headquartered groups with an Irish financing company

Whilst the impact on Irish financing companies of the interaction of interest deduction restrictions, BEAT and GILTI under the TCJA will depend based on specific circumstances, the table below aims to give a general overview of the key tax points of note.

Scenario

Potential tax considerations

1.    US HQ Group, with Irish FinCo lending into the US.

·       Interest deduction in US may be limited to 30% of EBITDA;

·       BEAT may apply to deductible interest ensuring 10% effective tax in US;

·       Additional incremental US tax under GILTI may arise if Irish effective rate less than 13.125%;

·       Benefit of 12.5% rate in Ireland potentially lost if BEAT and GILTI both apply.

·       If BEAT not triggered, Irish FinCo still tax efficient but benefit may be smaller due to 30% interest limit and GILTI

2.    US HQ Group, with Irish FinCo lending to non-US

·       Possible interest restriction for lending to non-US country (depending on local interest restriction rules e.g. application of 30% EBITDA limit under ATAD);

·       GILTI may apply if Irish effective rate less than 13.125%;

·       Benefit of 12.5% rate still likely to be retained if Ireland is funding operations in a jurisdiction with a higher tax rate

3.    Non-US HQ Group, with Irish FinCo lending to US

·       Interest deduction in US may be limited to 30% of EBITDA;

·       BEAT may apply to deductible interest ensuring 10% effective tax in US;

·       No GILTI impact;

·       Benefit of 12.5% rate in Ireland could still be significantly reduced if BEAT applied;

·       If BEAT not triggered, Irish FinCo still tax efficient but benefit may be smaller due to 30% interest limit


Conclusion

In summary, it is likely that any Irish financing entities that have related US entities, be it a US parent company or US counterparty to a debt arrangement, will likely be impacted in some way by the TCJA. However, in many instances, Ireland should still be a viable location for group treasury operations to fund US and non-US operations. Consideration of the impact of the TCJA, should be factored into any future intra-group lending activity, along with other tax, transfer pricing, legal, accounting, treasury and commercial factors.

Written by Shane Murphy, Tax Director in the Corporate and International Tax Group in Deloitte.

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