Article

US Tax reform proposals

Initial analysis 

US Tax reform – The Impact on Ireland

The Tax Cuts and Jobs Act (“TCJA”) proposed by the Congressional Republicans brings about significant changes to several aspects of the US tax code. The pace of change in this proposed legislation has been swift, with various versions of the proposals being made public to date. 

On Thursday, November 9, the Ways and Means Committee approved the TCJA, H.R. 1 (the “W&M bill”), which was originally released on November 2 and subsequently amended. On the same day, Senator Orrin Hatch (R-UT), Chairman of the Senate Finance Committee, had the staff of the Joint Committee on Taxation (JCT) release its “Description of the Chairman’s Mark” of the TCJA, a proposal to be marked up by the Senate Finance Committee the week of November 13 (the “Senate proposal”). 

US tax reform has been anticipated for more than a decade, and is a key part of both President Trump and the GOP’s legislative agenda. The TCJA is a detailed piece of legislation and represents the most substantial changes to the US tax code since 1986. Both the House W&M bill and the Senate proposal diverge on certain key aspects, and it remains to be seen how the differences between the two will ultimately be reconciled. Given the complexity of the legislation, and the uncertainty of the final provisions which may ultimately be signed into law by President Trump, greater analysis will be required and will be issued in due course. 

What follows below is a brief look at some key provisions of both the W&M bill and Senate proposal from an Irish perspective. Detailed analysis of the original and amended W&M bill is available here and here. A detailed analysis of the Senate proposal is available here.

Key international tax measures common to both versions

Rate Change                                 

Both the W&M bill and Senate proposal would reduce the general corporate tax rate to 20%, which is down from a maximum tax rate of 35%. The W&M bill rate reduction would be immediate rather than implemented using a phased approach and would be effective from January 1, 2018. The Senate proposal is similar but would appear to delay implementation of the rate reduction by one year.

The 20% rate of corporation tax is still materially higher than Ireland’s 12.5% rate. We would not anticipate a cut in the headline rate having a significant impact of US firm’s foreign direct investment into Ireland. Such investment is largely driven by Ireland’s attractiveness as a location for doing business in Europe, of which our headline corporation tax rate is one of many important elements.  

Territorial System

Both versions of the bill include an exemption for foreign-source dividends from certain foreign companies. In particular, corporations that are shareholders of a foreign corporation (i.e. “10% owned foreign corporation”) will have a 100% dividends received deduction on the foreign-source portion of any dividends paid by the foreign corporation. This has been described publicly as a move to a “territorial” system. Key differences between the W&M bill and the Senate proposal are that the Senate proposal includes: 

  1. A limitation on the dividends-received deduction for any dividend received if the foreign corporation receives a deduction (or other tax benefit) from taxes imposed by a foreign country (hybrid dividend) and 
  2. An expanded holding period requirement of 12 months compared with 6 months in the W&M bill.

In addition, any hybrid dividend received by a controlled foreign corporation is treated as subpart F income for the taxable year such dividend was received.

A large number of OECD member states already exempt certain foreign-source income as a means to mitigate double tax, and as such it is not expected that the move by the US would have significant impact on Ireland. The Department of Finance is also currently engaged in public consultation following the Coffey report on Ireland’s corporation tax code, and part of this consultation considers whether Ireland should also move to an exemption-based or so called “territorial” system for the mitigation of double tax.

Deemed Repatriation Tax                                                                     

A one-off deemed repatriation tax has been suggested in the both the W&M bill and Senate proposal. In the W&M bill, broadly a US shareholder company owning at least 10% of a foreign subsidiary should include in its income, in its year in which the subsidiary’s last tax year beginning before 2018 ends, its share of the accumulated post-1986 deferred foreign income of that foreign subsidiary. 

Similar to the W&M bill, the Senate proposal provides that a US shareholder of a “specified foreign corporation” (“SFC”) must include in income for the SFC’s last tax year beginning before January 1, 2018, the shareholder’s pro rata share of the foreign corporation’s undistributed, non-previously taxed post-1986 foreign earnings. For purposes of the proposal, an SFC is any foreign corporation that has at least one US shareholder. Unlike the W&M bill, the Senate proposal modifies the definition of a US shareholder to include not only US persons who own 10% or more of the total combined voting power in the foreign corporation, but also any US person who owns 10% or more of the total value of the foreign corporation.

Under the W&M bill, the amount of such deferred income generally takes into account earnings and profits as of November 2, 2017, or December 31, 2017 (whichever is higher) without a reduction by reason of dividends distributed in the year that includes such date.  The netting of earnings and deficits takes into account the US shareholder’s earnings and profits deficits of foreign subsidiaries of the US shareholder or members of the US shareholder’s affiliated group. The measurement date for deferred foreign earnings is November 9, 2017, or “other applicable measurement date as appropriate” under the Senate proposal (rather than November 2 or December 31, as under the W&M bill) unreduced by distributions during the taxable year to which the provision applies. Apparently in contrast to the W&M bill, the earnings taken into account in computing the mandatory inclusion are only those for periods when the foreign corporation was an SFC. Such earnings generally may be reduced by foreign E&P deficits of other foreign corporations that are properly allocable to the US shareholder by reason of other foreign corporations with such deficits.

Under the W&M bill the deemed repatriation tax on foreign-source income held by US multinationals on cash assets is 14%, with the rate on noncash assets being 7%. This tax can potentially be reduced a proportionate share of the foreign taxes deemed paid upon the inclusions.  In the Senate proposal, the rate of tax on the mandatory inclusion (before taking foreign tax credits into account) is 10% to the extent of cash assets of the US shareholder’s SFCs, and the remainder is taxed at a 5% rate. Foreign tax credits for taxes deemed paid as a result of the deemed repatriation are correspondingly reduced.  

For instance a US company holding shares in an Irish company may be subject to this tax, but if that company has paid Irish tax the US tax can be reduced. If passed this measure could add significantly to the administrative burden on US groups and possibly costs depending on the tax relief given.

The inclusion of a one-off deemed repatriation event has been anticipated as part of any tax reform package for a number of years, and thus its inclusion in the bill is not a surprise to an Irish or US audience. Indeed, tax “holidays” have occurred in the past, the latest of which occurred in 2004.

Limitation on interest deductibility

The W&M bill rewrites section 163(j), making it a rule that limits the deduction for the “business interest” expense of every taxpayer, corporate or otherwise, to the amount of the taxpayer’s business interest income plus 30% of businesses adjusted taxable income. Any deductions disallowed could be carried forward for only five years. This provision does not apply to a business with average gross receipts of $25 million or less, or to certain regulated utilities and real property trades or businesses. 

In a provision similar to the W&M bill, the Senate proposal would entirely revise section 163(j), making it a rule that would generally apply (subject to the exceptions mentioned below) to every business, regardless of its form, and disallow the deduction for net interest expense in excess of 30% of the business’s adjusted taxable income. However, the Senate proposal appears to define adjusted taxable income more narrowly, as NOLs and depreciation deductions would not be “added back” to determine adjusted taxable income, which could be significant in light of the 100% “bonus” depreciation for certain property provided in the proposal. The Senate proposal would permit disallowed deductions to be carried forward indefinitely. Exceptions are included for taxpayers with average annual gross receipts of less than $15 million, regulated public utilities, and real property businesses that elect to be excepted from the rule.

Interest paid by a domestic corporation that is a member of an international financial reporting group

Under the W&M bill provision, interest deductions of a US corporation that is a member of an international financial reporting group are generally limited to 110% of the US corporation’s proportionate share of the group’s reported net interest expense, where the proportion is based on the ratio of US corporation’s earnings before interest, taxes, depreciation, and amortization (EBITDA) to the group’s EBITDA. This limitation applies in addition to the general rules for disallowance of interest expense elsewhere in the code and taxpayers would be disallowed interest deductions pursuant to whichever provision denies a greater amount of interest deductions. Any disallowed interest expense can be carried forward for up to five tax years, with carryforwards exhausted on a first in, first out basis.

An international financial reporting group is a group of entities that includes at least one foreign corporation engaged in a trade or business in the United States, or at least one domestic corporation and one foreign corporation; prepares consolidated financial statements; and has annual global gross receipts of more than $100 million.

The Senate proposal would limit interest deductions to the extent attributable to excess borrowing in the United States. Although conceptually similar, the mechanics of the Senate proposal and the W&M bill are different – the Senate proposal is based on debt/equity ratios, while the W&M bill uses EBITDA ratios. Under the Senate proposal, interest paid by a domestic corporation that is a member of a worldwide affiliated group is reduced by the product of the domestic corporation’s net interest expense multiplied by the “debt-to-equity differential percentage” of the “worldwide” affiliated group (which would include foreign corporations, and for which the ownership threshold would only be 50%). 

The debt-to-equity differential percentage means, with respect to any worldwide affiliated group, the excess domestic indebtedness of the group divided by the total indebtedness of the domestic corporations that are members of the group. All US members of the worldwide affiliated group are treated as one member for these purposes.

Excess domestic indebtedness is the amount by which the total indebtedness of the US members exceeds 110% of the total indebtedness those members would hold if their total indebtedness to total equity ratio were proportionate to the ratio of total indebtedness to total equity in the worldwide group.

W&M bill

Excise Proposal

Under the excise proposal, certain tax deductible payments made by a US company to a related foreign company (which could be Irish) are subject to a 20% “excise tax”.  This tax should not apply where the related foreign company elects to treat the payments as income effectively connected with the conduct of a US trade or business. Consequently, the foreign company’s net profits (or gross receipts if no election is made) with respect to those payments would be subject to full US tax. A foreign tax credit for 80% of tax paid would however be available.  

There are certain exceptions for intercompany services which a US company elects to pay for at cost (i.e. no mark-up is applied) and certain commodities transactions. If implemented the measure could increase the relative attractiveness of the US as a base of operations, given that exporting into the US would make such activities more expensive. This may have knock on consequences for US multinationals with foreign operations, including Irish and other worldwide subsidiaries. However, given this measure is absent from the Senate proposals it remains to be seen whether it will make it through to the bill ultimately signed in to law. If it does pass, the final measure might be substantially different from that contained in the bill at present and its impact on Ireland will need to be assessed accordingly. 

Income Inclusion for Foreign “High Return Amounts”

The current version of this measure would require US shareholders to include in gross income 50% of its Controlled Foreign Companies (“CFCs”) income for that year which is deemed to represent “high” returns amounts (“FHRA”) on investment. There is a separate but similar provision included in the Senate proposal which is discussed below. 

FHRA are generally based on the excess of the US parent’s foreign subsidiaries’ aggregate net income  over a routine return (7% plus broadly the federal short-term rate) on the relevant portions of the foreign subsidiaries’ aggregate adjusted bases in their depreciable tangible property, adjusted downward for interest expense.

Inclusions of FHRA trigger deemed payments, by the US parent, of the subsidiaries’ foreign income taxes. However, the taxes will be deemed paid only to the extent of 80% of the relevant portion of the controlled foreign corporation’s foreign income taxes. The FRHA provision would ensure that the “high returns” on the “tested” income of a US shareholder’s CFCs will bear current worldwide income tax at a rate (across all income of all of a US shareholder’s CFCs) of no less than 10%; for example, in a case where no foreign tax was paid or accrued by a US shareholder’s CFCs.

If the CFCs paid or accrued foreign income taxes attributable to the “tested” income in the inclusion year, but the average effective rate of such taxes for the year is less than 12.5%, then there would be additional tax imposed by the United States. The significance of the 12.5% rate in this context being that where there is a foreign effective income tax rate of 12.5% or less, the foreign taxes will be deemed paid only to 80% of this amount, thereby limiting the deemed payment of foreign tax deduction to 10%.

The relevant “tested” income of any CFC is generally its residual income after removing effectively connected income, related-party dividends, subpart F income, certain income that would be foreign personal holding company income if not for active business exceptions or the CFC look-through rule, and income that would be subpart F income but for the high-tax exception.

Based on the current provisions of the W&M bill it would appear Irish CFCs are no worse off than CFCs based in other jurisdictions, given that those CFCs in other jurisdictions with an effective rate of local tax on “tested” income of greater than 12.5% will still end up paying a higher effective rate of tax overall. In any event CFC rules form a core anti-avoidance measure of territorial systems generally, and are a key part of the tax legislation of many other jurisdictions globally.

Clearly the profits of subsidiaries based in lower tax rate countries or tax havens may fall within the scope of this provision.  Given that such profits have been earned from the major consumer markets globally, such provision could be seen as the US version of a BEPS type approach.

The interaction with the various unilateral rules now in force in various countries and BEPS type rules that will be implemented by many of the OECD countries over the near future will need to be considered once the final format of these proposals is known.

Senate Proposal

Global Intangible Low-Taxed Income

The Senate proposal includes a provision requiring a US shareholder of CFCs to include in its gross income its Global Intangible Low-Taxed Income (“GILTI”). GILTI is the excess of the shareholder’s “net CFC tested income” over the deemed tangible income return, which is defined as 10% of the aggregate of the shareholder’s pro rata share of its CFCs’ bases in tangible property used to produce “tested income.” Similar to the Foreign High Returns provision in the W&M bill, net CFC tested income is the aggregate of the US shareholder’s pro rata shares of the “tested income” (if any) of each of its CFCs, reduced by such shares of the “tested loss” (if any) of each of its CFCs. Tested income is the gross income of a CFC, determined without regard to certain amounts, less deductions (including taxes) properly allocable to such gross income and certain exceptions. 

A corporate US shareholder can claim a foreign tax credit for 80% of the aggregate taxes paid or accrued with respect to the tested income of each CFC from which the shareholder has an inclusion. 

The GILTI proposal differs from the FHRA proposal in certain respects. The category of CFC income “tested” for the GILTI inclusion is broader than that tested for the FHRA. A shareholder’s increase in income resulting from the inclusion would be greater under the GILTI proposal. While the FHRA inclusion under the W&M bill is only 50% of the FHRA, in the case of a corporate US shareholder, the Senate proposal generally would require an income inclusion of 62.5% of GILTI after a separate deduction. No such deduction is available for non-corporate US shareholders.  

The proposal generally assures that either CFC tested income is taxed abroad at an average effective rate of 15.625% or the US will impose tax on a US corporate shareholder’s GILTI such that it bears a minimum of 12.5% tax worldwide. The allowed tax-free return on CFCs’ tangible asset bases is slightly higher under the GILTI proposal. The 20% haircut of foreign taxes that are eligible to be credited by a corporate US shareholder would be the same under both proposals. As with the FHRA, the significance of the 15.625% rate in this context being that where there is a foreign effective income tax rate of 15.625% or less, the foreign taxes will be deemed paid only to 80% of this amount, thereby limiting the deemed payment of foreign tax deduction to 12.5%.

Similar to the FHRA provision, under the GILTI it would appear Irish CFCs are no worse off than CFCs based in other jurisdictions, given that those CFCs in other jurisdictions with an effective rate of local tax on “tested” income of greater than 15.625% will still end up paying a higher effective rate of tax overall. 

Partial corporate deduction for GILTI inclusion and foreign-derived intangible income

The Senate proposal provides that a domestic corporation is allowed a deduction for 37.5% of the lesser of (1) its GILTI inclusion plus its “foreign-derived intangible income,” or (2) its taxable income.

“Foreign-derived intangible income” is an amount equal to the corporation’s deemed intangible income multiplied by an amount equal to the corporation’s “foreign-derived deduction eligible income” over its “total deduction eligible income.”  

“Deduction eligible income” is the excess of the gross income of the corporation, determined without regard to certain amounts, over the deductions (including taxes) properly allocable to such gross income, subject to certain exceptions.

 “Deemed intangible income” is the excess of a corporation’s deduction eligible income over 10% of the basis in its tangible depreciable property used to produce deduction eligible income.

Royalty income appears to be “deduction eligible income,” and therefore would be included in “deemed intangible income.” However, it is unclear whether foreign-source royalty income, including Irish-source royalty income, falls within the definition “foreign-derived deduction eligible income.” 

Special rules for domesticating IP

The Senate proposal also contains a rule presumably intended to incentivize the “domestication” of IP by providing that if a CFC holds intangible property on the date of enactment, and distributes it to a corporate US shareholder by the end of the CFC’s third tax year beginning after 2017, the fair market value of the property on the date of the distribution is treated as not exceeding its adjusted basis. In addition, if this distribution is not a dividend, the CFC’s stock basis would be increased to prevent the shareholder from recognizing a gain. As a result, the CFC’s US shareholder would not recognize income as a result of the distribution of IP.

If enacted in its proposed form, certain taxpayers would need to carefully consider whether to onshore or “domesticate” IP to the US. 

Base erosion anti-abuse tax (“BEAT”)

In lieu of the W&M bill’s proposed excise tax on “specified amounts” paid by domestic corporations to their foreign affiliates, the Senate proposal requires a corporation that is an applicable taxpayer to pay a tax equal to its “base erosion minimum tax amount” (“BEMTA”) for the taxable year

BEMTA is the excess of 10% of the corporation’s “modified taxable income” (taxable income determined without regard to “base erosion tax benefits,” namely, deductions for “base erosion payments”) over its regular tax liability reduced by credits other than the research credit.

A “base erosion payment” is generally any amount paid or accrued by a taxpayer to a foreign person that is a related party (generally, with a 25% “relatedness” threshold) and with respect to which a deduction is allowable.  It includes any amount paid or accrued by the taxpayer to the related party in connection with the acquisition of depreciable or amortizable property. 

While the Senate proposal is described as an “inbound provision,” it appears (like the W&M bill’s excise tax) to apply to US-parented multinationals as well. It should be noted that, unlike the excise tax proposal in the W&M bill, interest deductions appear to be within the scope of the BEAT. The impact of the final provision on Irish companies will be considered in further detail. 

Conclusion

We will be sending a separate note on the impact for Irish public listed companies and large private companies doing business in the US.  In the meantime with the pace of change to this draft law, your team at Deloitte are available to discuss with you and scenario plan.

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