By Scott Wentz, Managing Director, US Tax, Radius
A new US tax proposal unveiled September 27 calls for significant changes in the way multinational companies are taxed, including a 20 percent corporate tax rate. The nine-page proposal, developed by a small committee of Republican senators and endorsed by President Trump, also changes the tax structure for individuals. The New York Times calls it “the most sweeping tax overhaul in decades.”
The plan needs a great deal of fleshing out and would have to be approved by Congress to become law. Here are some of the most important features for US-based multinationals and foreign companies with a permanent establishment in the US.
Lower corporate tax rate. To make American companies more competitive, the plan would lower the corporate tax rate from 35 percent to 20 percent, a rate it says is below the 22.5 percent average of the industrialized world. It would also eliminate the corporate Alternative Minimum Tax and says it “may consider methods to reduce double taxation of corporations.”
25 percent rate for pass-throughs. For partnerships, limited liability companies, S Corps and other non-corporate business structures that pass earnings through to their owners (who pay taxes based on their individual rates), owners would pay a flat 25 percent. Currently, rates top out at 39.6 percent.
The 25 percent rate, however, would not apply to everyone. Officials have said the lower rate won’t apply to personal service providers such as accountants. It is possible that attorneys, architects, doctors and other service providers could also be included in the personal service category.
Pass-throughs account for more than 40 percent of net business income in the US. Critics of this part of the plan say it may encourage high-wage earners to form pass-through structures to lower their taxes. The proposal calls for committees to establish rules to prevent gaming the system.
One-time tax on accumulated foreign earnings. Unlike the situation in most OECD nations, US-based multinationals pay US taxes on their earnings abroad in addition to the foreign taxes they pay. Multinationals based outside the US usually pay taxes only to the country where their operations take place. In addition, the US corporate tax rate is the highest in the OECD. But US companies are only taxed on overseas profits when they are “repatriated,” or brought to the US.
As a result of these policies, many US multinationals have moved operations overseas and do not repatriate their profits. Some, particularly in the technology and pharmaceutical sectors, have “inverted” their business structure to make their headquarters in a low-tax country such as Ireland, the Netherlands or Hungary instead of the US. Fortune 500 companies currently hold nearly $2.5 trillion in accumulated profits abroad. Because of corporate inversions and exemptions, few US multinationals actually pay the 35 percent rate on all their profits.
The new GOP plan calls for a one-time tax to be levied on accumulated overseas profits. Illiquid assets like factories or research labs would be taxed at a lower rate than cash and securities. The rates themselves are unspecified and would be set by Congress. (During the election campaign, Trump suggested a rate of 10 percent.)
Companies would be able to spread tax payments over several years. They would not necessarily have to sell and repatriate assets stashed abroad, as long as they paid taxes on them (“deemed repatriation.”)
This measure could produce a one-time windfall of over $100 billion in tax revenue of the US.
Switch to a “territorial” system, but with a caveat. After paying the one-time tax bill, the proposal says companies would be switched to “territorial” taxation, which is usually defined as paying taxes only to the country where operations are located.
But the proposal’s interpretation is different. To keep companies from shifting profits to tax havens and to strengthen the US tax base, foreign profits of US-based multinationals would still be taxed — but “at a reduced rate and on a global basis.”
The proposal’s lack of specificity about tax on foreign profits worries businesses, which would prefer an unqualified territorial system similar to that of European nations.
The proposal does, however, provide a 100 percent exemption for dividends from foreign subsidiaries in which a US parent company owns at least a 10 percent stake.
Limits on interest expense deductions. The plan calls for limits on deducting corporate interest expenses, without being specific. But it also allows companies to immediately write off investment expenses for the next five years.
Fewer tax credits. The plan preserves tax credits for research and development and low-cost housing, but eliminates most others.
The proposal offers potential good news to multinationals, but important details have yet to be worked out. Though Republicans support the plan and hold a two-vote majority in the Senate, obtaining support in a divisive Congress could prove to be a problem.