The results of the US elections in November caught many by surprise with unexpected outcomes. Few predicted Republican candidate Donald J. Trump would be elected to serve as the next President. Republicans also retained majorities in both the US Senate and US House of Representatives. Expectations were for a split government for another 4 years with little tax legislative change. Now with the Republicans in control of Congress and the White House, the chance that comprehensive US tax reform will be enacted in the near future is likely greater than at any time in the last several decades.
Throughout his election campaign, President-elect Trump stated that fundamental tax reform designed to significantly lower both individual and business tax rates and to make the US more competitive in the global marketplace was one of his top priorities. Congressional Republicans put together the House Republican ‘blueprint’, released in June 2016, as a starting point for tax reform but the blueprint received little attention prior to the November elections. This has changed!
Many clients around the world have expressed great interest in what changes may be coming in the US in terms of international and domestic tax rules and how those changes could impact their business. Although it is too early to tell what tax reform will look like in final legislation and what effective dates will apply to the new rules, there are several proposals that should be considered. The following is a high-level list of talking points highlighting some of the more significant tax reform proposals that have a reasonable possibility of enactment. If you or your clients would like to discuss further, please feel free to reach out to Robert Davidson, and/or Ashley Marco.
US Tax Reform Items
Reduction in Corporate Income Tax Rate
Per Trump’s proposal, the business tax rate would drop to 15%. Per the House Republican blueprint, the business tax rate would drop to 20%. Both plans would eliminate Alternative Minimum Tax.
Impact/Opportunity: A significant reduction from the current corporate tax rate of 35% would present a one-time opportunity to generate a permanent tax benefit by accelerating deductions into a 35% tax rate year and/or deferring revenue to a year with a lower rate. Impact on Deferred Tax balances would need to be considered.
Elimination of Corporate Tax Deductions
Trump has proposed that ‘most business tax expenditures’ would be eliminated, with the exception of the research tax credit. The House blueprint takes a similar approach in that it too calls for eliminating numerous business tax deductions and credits. Additionally, Trump has proposed that US-based manufacturers would be allowed to make an election to fully expense plant and equipment, but would not be allowed to deduct net interest expense if this election is made.
It is likely that mandatory deemed repatriation of US companies’ untaxed foreign earnings will be part of any reform proposal considered by Congress. Trump’s proposal calls for a mandatory deemed repatriation of previously untaxed foreign earnings at the rate of 10%, while the House blueprint considers a repatriation tax of 8,75% for cash/cash equivalents and 3,5% for other accumulated foreign earnings.
Impact/Opportunity: Multinational companies should begin urgent planning to assemble data on their post-1986 foreign earnings that would be subject to a repatriation tax and undertake an E&P accounting methods study to examine more favourable methods. Companies should also consider the timing of the repatriation of earnings to the US to optimize the tax rate applicable to those earnings.
Cross-border Taxation Changes
Under the House blueprint, the US would shift to a territorial tax system in which it would exempt 100% of dividends and impose a mandatory deemed repatriation of tax (8,75% for cash/cash equivalents and 3,5% for other accumulated foreign earnings). Additionally, a border adjustment consumption-type tax may be imposed whereby the US would begin taxing imports and exempting exports. This could result in significant “winners and losers” depending on a company’s supply chain.
Impact/Opportunity: Companies should analyse the potential cost and effective tax rate impacts of such proposals. To prepare for this potential tax reform legislation, companies could consider possible supply chain changes or reorganisations, including potential, broad-based operational changes such as plant relocations, which will merit C-suite discussions and consideration. The location of Intellectual Property could turn conventional planning on its head.
Section 385 and other Regulations
As part of the potential tax reform, the controversial Section 385 regulations related to the classification of debt vs. equity may be withdrawn. Additionally, other recently issued tax regulations may be withdrawn or revised under the new legislation.
Impact/Opportunity: While multinationals, especially US inbounds, should monitor the developments closely, it is not advisable to cease efforts to comply with the legislation that has been passed.
New Tax Rate for Pass-through Entities
Based on the two proposals, the taxation of pass-through entities is likely to change. Per Trump’s proposal, the owners of these pass-through entities could elect to be taxed on their pass-through business income at 15%. Under the House Republican blueprint, these entities would be taxed at a rate of 25%.
Impact/Opportunity: Taxpayers should consider the type of entity they are using to conduct business, as some entity types may enjoy more favourable rates. An entity conversion study can help ensure that appropriate issues are examined.
The tax landscape in the US remains uncertain but the November elections have given new life to the idea of reforming the US tax system to make the US more competitive in the global marketplace and stimulate the US economy. President-elect Trump and his administration have indicated tax reform is a key priority from the moment he takes office on 20 January. Staying on top of this evolving topic is critical for companies to appropriately plan and act to take full benefit of the opportunities presented.