US tax reform – what does it mean for New Zealand
Tax Alert - February 2018
By Bruce Wallace & Emma Marr
The US has recently enacted some of the most radical tax reforms it has seen in decades. This will have a significant impact on New Zealand companies doing business in the United States. The Tax Cuts and Jobs Act bill was signed into law by President Trump on 22 December 2017, and generally has effect for tax years beginning after 31 December 2017.
New Zealand companies should consider the impact on their businesses, including current organisational structures, supply chains, transfer pricing, debt structuring, profit repatriation, intellectual property (IP) ownership, and planning opportunities that may result. This article highlights some of the most relevant issues for New Zealand businesses to consider. More detail can be found in a report published by Deloitte US.
Corporate income tax
One of the most attention grabbing reforms is the reduction in the Federal corporate income tax rate from 35% to 21% beginning January 1, 2018. Compared to the OECD average of 24.18%, this is a major reform, and is likely to prompt a re-examination of existing cross-border transactions. As the tax rate is significantly lower than New Zealand’s 28% corporate tax rate, and many other tax rates around the world, there may be an incentive for businesses to allocate profits to the US, although state income taxes also need to be considered. Businesses should consider whether this presents an opportunity to revisit their operating model.
The corporate tax reduction is partially offset by some broadening of the tax base, for example the elimination or limitation of certain deductions, discussed further below, however there is no doubt that this tax cut will be a significant boost to most US companies.
Currently the US has an “alternative minimum tax”, which acts to ensure that taxpayers who are entitled to reduce their taxable income via various deductions or incentives do pay a specified minimum amount of tax. The tax reforms repeal the AMT for corporations. This is to some extent counterbalanced by limitations to newly generated net operating loss carry-forward amounts, discussed below.
The rules allowing a net operating loss (NOL) to be carried forwards or backwards have been tightened. Previously a NOL could be carried forward 20 years and carried back two years. Under the tax reforms, the deduction for NOLs arising in taxable years beginning after December 31, 2017 is limited to 80% of taxable income and the two-year carry-back for NOLs is repealed. NOLs generated from tax years beginning after December 31, 2017 for most business taxpayers will not expire. NOLs existing at December 31, 2017 still expire in 20 years and are not limited by the 80% reduction. These changes create a cash tax cost for taxpayers traditionally sheltered by NOLs.
Corporate interest deductions will be subject to greater limitations under the new legislation. Interest deductions are now limited to the total of business interest income and 30% of adjusted taxable income (ATI). Interest deductions that are disallowed may be carried forward indefinitely.
The 30% limitation applies to all net interest expense, not just interest paid to, or guaranteed by, a foreign-related party like the former rules did. The definition of ATI is detailed, and is closely linked to earnings before interest, taxes, depreciation and amortization (EBITDA) until 2022, after which ATI more closely resembles earnings before interest and taxes (EBIT).
Current asset expensing
Another significant reform is the ability for businesses to immediately deduct 100% of qualified capital expenditure. This will apply to all tangible assets, including second hand assets. As with a number of other tax reforms, this is subject to a sunset clause and begins to be phased out after 2022.
International tax reforms
A number of international tax reforms could be relevant for New Zealand companies with US resident shareholders, or New Zealand companies with operations in the US.
Dividends received deduction
The treatment of foreign dividends derived by US companies is fundamentally reformed by giving corporations a 100% deduction (i.e. exemption) for dividends received from a controlled foreign corporation (CFC) in which the US shareholder owns 10% or more. The former rules taxed profits of foreign subsidiaries only on repatriation to the US. Transition rules will prevent the non-taxation of deferred foreign income by imposing a one-off transition tax on un-repatriated earnings. This change is expected to lead to a substantial repatriation of capital by US corporations from abroad.
Excise/base erosion tax
The tax reforms include base erosion measures in the form of a “minimum tax” to offset the benefit of “base erosion payments” – certain payments to foreign related parties. The US payer will have to pay a tax of at least 10% (5% for 2018 under certain transition rules) on taxable income, computed without regard to the related party payment. Base erosion payments will include many deductible payments to foreign related parties. The rule will apply to corporate groups with an average of $500 million annual revenue in the US for the last three years, and a base erosion percentage of more than 3%.
The new base erosion tax will be an important factor for multinational taxpayers to consider in evaluating their supply chain and transfer pricing policies, and cross-border interest and royalty payments.
As with other countries around the world, the US has introduced special provisions to deal with hybrid structures and transactions. Hybrids exploit differences in tax regimes, for example by allowing a deduction in one country, where the amount is not treated as income in another, or by treating an entity as transparent in one country, but not another, so that it isn’t taxed in either country. The new rules are significantly more limited than the OECD proposals that are proposed to be adopted in New Zealand and will deny a deduction for disqualified related party amounts (interest or royalties) paid or accrued under a hybrid transaction or to a hybrid entity.
As New Zealand taxpayers will be subject to New Zealand’s own new anti-hybrid rules when they are enacted later in 2018, the US reforms mean there is even greater incentive for New Zealand companies operating in the US to evaluate all cross-border transactions and address any that will give rise to denial of deductions.
State tax reform
It should be remembered that the US has state as well as federal taxes, and individual states have the ability to either decouple from select provisions or choose to confirm with the reforms on a date preceding the new legislation. Likewise, states may piggyback on some proposals such as the proposed base erosion tax to create new tax revenues.
Businesses should be careful to keep an eye on state tax reforms as they get underway early in 2018.
The US tax reforms are significant and New Zealand companies operating in the US, investing in the US, or owned by US shareholders should consider how these changes may impact their businesses, and identify any new planning opportunities now available. Contact your Deloitte advisor to discuss the impact of these potential changes on your business, and how you can prepare for them.