United States: The Ways New Corporate Tax Laws Are Affecting Businesses Operating In The US

Last Updated: March 8 2018
Article by Jason Gerlis

The dust is settling on December's tax reform bill - the most sweeping overhaul of the US tax system in more than three decades - and the market has now had some time to analyse its implications.

On the surface, it seems slashing corporate tax from 35% to 21%, as well as installing lower taxes on overseas profits, would be a boon for businesses operating in the US. Indeed, this falls directly in line with the "America first" attitude we have seen from the current administration.

However, as always, things are not that straightforward. There are three main topics of discussion we are hearing in the industry right now, both from clients and from our partners in the advisory space: the simplification of the tax code and the reduction in the federal base rate; repatriation of foreign-held earnings; and the move to a territorial system of taxation. Let's look at these in turn and explore the way they will affect US companies.

Less tax does not equal higher gross earnings

The US tax code has been very complicated for a long time, so the reduction in the base tax rate is not necessarily as straightforward as people think. For many years companies have been able to take advantage of various deductions to compensate for the 35% corporate tax rate, and the simplification of the tax code means that many of these will disappear. Therefore, it is not correct to say simply that taxes are less; there are some firms that will end up paying a lot less, and there are some firms that also now have to disentangle themselves from various historical deductions, and who may find that the overall effect is a lot less positive.

So, as ever, there are winners and losers, with many companies now paying "extra" wages, gratifications, and so on, while others indicate they will need to write down on NOLs and carry-forwards. A lot of firms are getting tax advice and trying to work out where they stand, how best to position themselves for a potential upside, and what to do with those tax windfalls if indeed realised. They want to know where any potential savings are best spent - is it to invest in R&D? Is it to invest in international expansion? They really need to make sure the lasting benefit of the short-term impacts is felt.

Bringing money back onshore might not bring the windfall you expect

The capital markets in the US continue to be bullish. The Dow did have a couple of rough days earlier this year, but that was mostly down to inflationary expectations and the likelihood of higher interest rates. Some even now say it was driven by robotisation of trading platforms - algorithms making odd decisions and overheating of the system - but whatever the reason for that slip, it was temporary and markets rallied.

Our partners and clients in structured finance, private equity and real estate maintain the positive outlook they had held in anticipation of this tax reform. We have not yet seen a roll-back of some of the regulations around Sarbanes Oxley and Dodd-Frank, which the market was also hoping for, but the financial markets feel they are in a business-friendly environment and are expecting there to be a lot of transactions over the next 12 months.

The likelihood is that many companies are going to take advantage of the tax break to bring foreign-held earnings back into the US. But beware the "toll charge": for the US to transition from a worldwide tax system to a territorial one - meaning that US companies are taxed only on US earnings - they're imposing a one-time mandatory repatriation tax imposed at a rate of 15.5% for earnings held in cash and cash equivalents, and 8% for non-cash earnings. The goal of this transition tax is to flush out all historic or deferred earnings and subject them to tax, allowing the new system to start fresh with earnings generated after the transition.

Post-transition, foreign-source dividends (that are not subpart F) should be eligible for a 100% dividends-received-deduction. This effectively makes a zero rate of tax in the US on repatriated foreign earnings, post-transition, so long as it doesn't fall into any anti-deferral rules (such as Subpart F or GILTI).

Repatriating earnings means companies will have many more investment options, even though they're still likely to pay more tax on repatriated money than the tax they're paying today on their offshore holdings. As the most active market in the world, there is great opportunity in the US for firms to broaden their investment strategies and optimise returns on their capital. Venture capital firms on the West Coast are expecting fundraising to be easier, and we are seeing a lot of interest in alternative investments as people explore for options for once the money has been brought home.

It's worth noting, too, that bringing these reserves back to US soil may also lead to restructuring or refinancing efforts. Alternatively, companies may decide to pass the benefit to different groups of stakeholders, including creditors, investors and staff. It is thought this will stimulate corporate investments or create higher consumption – that is, it will bring renewed confidence, leading to economic growth that should in turn result in higher tax receipts. The hope is that these effects will offset the net reduction in the flat rate and result in the scheme paying for itself, but only time will tell.

When it comes to corporate structuring, the rules have changed

Of course, as the US moves into a territorial system of taxation and as the tax rate lowers, many firms are restructuring or looking into how to restructure their operations. The tax advisors we work with are doing a lot of that at the moment, and we are seeing companies coming out the back end feeling dizzy. They have been given a lot of advice, but don't really know what to do next.

A specific clause that will make a large impact is the limitation on US interest deductibility and the impact this will have on US acquisitions – this means that it will be more difficult to thinly capitalise domestic purchases. It seems this will drive an increase in foreign M&A – that is, US firms purchasing internationally in order to access easier financing. This is a continuation of a recent trend, whereby US firms look abroad to broaden their operations, expand into new markets and find the best strategic opportunities.

We expect to see a lot of existing structures dissolved and then new holdings set up, as businesses reorganise themselves to optimise the recognition of revenue, and profits meet the demands imposed by the new US and international tax frameworks. Certainly, that is what we have seen over the first two months of 2018, and expect to more of as the changes really take hold.

Of course, it may not only be the corporate, tax and financial structures that need to be reviewed – the IP structure should also be considered, and it is advisable for companies to review their governance and value chain. It's not just the new US tax plan that will affect US companies, as the global environment induced by BEPS will also make an impact.

Changes are coming from all sides while exchange of information is increasing. Tax revenues tend to be looking at enforcement and dispute tax positions much more as they try to get the biggest share of a company's tax pie. This requires secure, consistent and coherent documentation, decision-making and reporting. The choice, then, is to ramp up internal support departments, or to look to professionals offering economies of scale, best practices and continuity.

These changes in the US mean you must look differently at foreign taxes. There is a lot of change and a lot of concepts that require redefinition. Companies need to create flexibility and agility in order to be able to respond to these changes, and also respond to the evolution of the underlying concepts that are there. Every guidance note issued by the OECD, or the UK, US or EU tax authorities, and so on, could affect a company, so they need to stay on their toes. It is almost like corporate kung fu: you must be super agile, you need to be able to both defend and attack aggressively in order to keep standing on your feet.

We all need to learn to play a new game 

Businesses operating in the US are trying to understand how the lower base rate is going to affect them, what deductions have been taken away and what they can do with the money that they are hopefully going to have left over. Once you have advice from the architect - from the tax advisor - you need to find someone to do the building. We all know that if you don't disentangle yourself properly, then five to 10 years down the line you could suddenly find there is a tax exposure or even a legal exposure that you thought you had disengaged from but is actually still looming over your head.

With this tax reform and code simplification, the US government has effectively changed the rules and regulations around building codes and specifications - so companies that used to have structures in A, B or C location need to change to X, Y and Z. Companies who had bridged in a certain way to be thinly capitalised now need to re-evaluate those loans. All of this results in a plan, a blueprint, and each of the companies we speak to are trying to understand how to take that blueprint and create the reality, to reconstruct their house. What these companies must then decide is who their builder will be.

If everything is held domestically, those companies are usually well serviced by local or even internal legal and financial teams. However, companies with even a slight level of foreign exposure will need to consider builders with international credentials to ensure everything remains compliant with issues such as BEPS, BEAT and GILTI. It means they'll get a much simpler, much broader view of how to deliver that design which the tax advisors have put forward.

To hear how TMF Group can help build your restructuring blueprint, get in touch with our US-based experts.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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