US Tax Reform: What can Swiss groups expect as reform is close to finalization

in Tax, 07.12.2017

It’s highly likely that the enactment of the most significant US Tax Reform since 1986 is just around the corner. How will the final reform affect Swiss groups? Here’s a short overview of the latest developments and their potential impact.

The US Congress appears very close to passing the most significant tax legislation in over 30 years. Since my last blog article in early November, developments have accelerated as the Republican party races to finalize the reforms:

  • On 16 November, the Republican majority in the US House of Representatives passed its version of the Tax Cuts and Jobs Act Bill.
  • On 1 December, the Senate approved its parallel tax reform by a 51:49 vote. The two versions of the bill must now be reconciled for Congress to achieve a compromise that is then passed on to President Trump for signature.
  • Last Monday, the House voted in favor of the formal House-Senate conference where work to harmonize the main differences between the bills will begin.

The rapid progress clearly suggests that prospects for success have significantly improved. Now, it appears that the question is not if Congress will succeed on passing tax reform but rather when.

Under both the House and Senate bills, not only the US but also foreign multinationals with US operations would be affected. Here’s a short overview of the latest developments and their impact for Swiss groups.

Rate reduction and changes in tax base

Both bills foresee a reduction of the federal tax rate from 35% to 20%. In addition, they foresee an accelerated – and under certain circumstances, even immediate – expensing for capital investments in certain new and used depreciable assets acquired and placed in service after 27 September 2017 and before 1 January 2023.

At the same time, the two bills introduce various tax-base enlargement measures including:

  • An interest deduction limitation that’s far more severe. The new limitation applies to all interest (not only disqualified interest) and does not provide for a ‘safe harbor’ debt-to-equity ratio of 1.5. Additionally, the limitation threshold is reduced from 50% of ATI to 30% of ATI (‘Adjusted Taxable Income’).
  • The 110% rule. In addition to the ‘30% limitation’, there’s another limitation that applies to large groups with gross receipts of more than $100 million annually. The 110% rule’ adds a limitation where US interest expense is disproportionate relative to multinational financial reporting group’s total financial statement reported interest expense. The deductible net interest expense of a US corporation that is member of an international financial reporting group may be limited to the extent that the US corporation’s share of the group’s total net interest expense exceeds 100% of the US corporation’s share of the group’s total EBITDA. Although the House and the Senate bills are generally similar regarding these limitations, there are some differences especially regarding determination of ATI and carryforward periods.
  • Limitations of Net Operating Losses (NOLs). The bills are generally similar and limit the annual use of NOLs carryforward to 90% if the loss corporation’s taxable income.
  • Elimination of certain deductions such as those for domestic production activities or deductions for employee’s benefits.

Swiss groups should review their current US financing structures and US NOLs situation. Groups in a capital-intensive business might benefit from both the reduction of statutory rate and the accelerated expensing for investment in US assets that could foster new investment in the US. Or, they may be hit by the limitation of interest deduction or the limitation of NOLs.

Move to territorial regime and mandatory repatriation

Both the House and the Senate bills represent a shift to a territorial regime with a participation exemption on foreign dividend income (but not on capital gains). Due to such fundamental change, US shareholders with an interest in a foreign corporation must include the undistributed, previously non-taxed foreign earnings that would be subject to a mandatory repatriation. And, as a result, immediately pay tax at a rate of 7-14.5% depending on the type of assets and the proposal. The current CFC (Controlled Foreign Corporation) and Subpart F (provisions that require immediate inclusion of certain types of foreign income into the US tax base) rules will be maintained with some amendments.

One important amendment is the introduction of ‘Foreign high returns or global intangible low-taxed income’ under the House bill (‘Global intangible low taxed income’ under the Senate bill) that would result in a 10-12.5% minimum taxation on foreign profits. This would result in a new sort of global minimum tax on US corporate shareholder’s pro-rate share of certain foreign subsidiary earnings. Essentially, the tax would amount to 10% of foreign subsidiaries’ non-subpart F/non ECI income exceeding a deemed routine return amount on tangible depreciable property. Foreign tax could be credited up to 80%.

Swiss groups with US subsidiaries that own foreign subsidiaries might be affected by these changes. They may be subject to mandatory repatriation for non-distributed earnings sitting underneath a US subsidiary. They may also be caught by the above mentioned changes in CFC rules.

Limiting Base Erosion: Excise Tax or ‘BEAT’?

Under the House bill, an excise tax of 20% would be imposed on any tax deductible payments by domestic corporations to related foreign corporations. This new tax would apply to virtually any form of deductible payment, other than interest (but including costs of goods sold, royalties, services, etc.). The excise tax would effectively deny the benefit of a deduction for covered payment unless the foreign recipient elects to treat the payment as effectively connected with a US trade or business (ECI). In such a case, they could benefit from a complex deemed-expense deduction and certain foreign tax credit. The effective date is delayed to tax years beginning after 31 December 2018.

Under the Senate bill, a Base Erosion Anti-Abuse Tax (BEAT) would be imposed on ‘bad’ payments. Unlike the excise tax, bad payments under BEAT do not include costs of goods sold but do include interest, royalties or service payments to foreign related parties. It operates as a minimum tax: it is imposed if 10% of the US corporation’s modified taxable income exceeds the tax computed under the regular rules. The effective date is earlier than under the House bill and the BEAT would apply to tax years beginning after December 31, 2017.

Whatever version appears in the final bill, it’s obvious that the rules briefly described above affect Swiss groups significantly. Industries relying on the ‘Swiss made’ label or on ‘Swissness’ such as the watchmaking, pharmaceutical or reinsurance sectors might be the most affected – especially by the excise tax. Swiss groups should therefore review their value chain. Companies distributing their products on the US market via their own distributors, may want to consider switching to either unrelated US distributors or direct sales from non-US.

Impact on financial reporting

From a financial reporting perspective, the changes impact the deferred tax positions under IFRS and US GAAP accounting standards. Provided the bill is signed by President Trump and subsequently ‘enacted’ in 2017, it must already be accounted for in the 2017 financial statements. If the reform is delayed to 2018, a disclosure requirement might have to be considered in the 2017 financial statements.

Steps to take

It’s very likely that the most significant US Tax Reform since 1986 will soon be enacted – even before the end of 2017. Regardless of the final bill’s appearance, it will affect Swiss groups by redefining all relevant tax attributes in the US, including the tax rate, tax base and treatment of intercompany transactions. Although the timing is overwhelming, Swiss groups should keep their head and take the following measures:

  • Assess the impact action-by-action with the help of modeling tools.
  • Identify any ‘quick fix’ measures to mitigate the impact and uncertainty in the short term.
  • Consider measures to mitigate the impact and uncertainty in the mid- and long term.

You should note that these measures may include restructuring the supply chain and take a holistic view in this kind of analysis by factoring in other international tax and regulatory developments (driven by BEPS, the EU or other regulations).

 

KPMG Switzerland is delighted to invite you to our webcast session that will focus on implications for Swiss groups. The webcast will take place on Friday 15 December 2017, 1pm CET (7am EST). Please use this link to register.

 

 

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