Since President Trump took office in January, there have been a lot of discussions about a significant reform of the US tax code, as such a reform had been set as a top priority for the new President. After first signals of a possible fundamental reform with fast implementation, the developments in the last few months have shown that this might not be the case. It seems that currently, almost everything is still up for negotiation. Repealing the Affordable Care Act (ACA) has taken precedence for the Trump administration and continues to consume resources and political capital in Washington. That said, the road to the passage of tax reform seems to stretch even longer and its content does not get clearer. As already mentioned in my blog in March, whatever and whenever it happens, not only US groups but also foreign groups with US presence and operations should be prepared for some possible major changes, not only affecting their bottom lines but also how they do business.
The last document in terms of possible content is the statement released by the “Big Six” in late July on “Principles for US Tax Reform.” Although significantly less specific than other documents already released, such as the House Blueprint released by the House of Representatives Republican Tax Reform Tax Force in June 2016, it was a critical step illustrating what is happening behind the scenes. This is a further indication that the principles of the reform are being actively debated within the Republican leadership in both the House and the Senate and by the White House. It is still uncertain to what extent the White House supports key aspects of the House Blueprint.
Good news: the controversial Border Adjustment Tax (“BAT”) seems to be off the agenda
Key to the House Republican tax proposal was a move towards a destination-based tax. The latest political discussions suggest that this controversial BAT would not be included in the reform proposal. This is definitely positive news from the perspective of an exporting economy like Switzerland. However, it is anyone’s guess whether the BAT might pop up later in the discussions, and the developments in this respect should be carefully monitored. In addition, the question of whether a national consumption tax will ever be adopted in the US continues to be debated.
What reduction of tax rates?
With a federal tax rate of 35% on corporate tax profits, the US is one of the few countries that has not reduced its corporate tax rate over the last years. According to the Republicans’ plans, the rate should be decreased to 15% (President Trump’s proposal) or 20% (House Blueprint). The latest public statements by political leaders have not provided further and more precise numbers on tax rates. What is certain is that without BAT – which was expected to raise about $1 trillion in tax revenue – lawmakers and the White House will need to find other ways to help offset tax cuts if they want to stick to their revenue-neutral plans and prevent tax reform from increasing the deficit.
Denial of deductions
Various proposals by Republican leaders included the limitation of tax deductions or of specific incentives. This mainly refers to interest deductions that would be denied except to the extent offset by interest income. Although this topic has not been addressed in the latest statements, it seems to be still under consideration. Foreign groups having highly leveraged US operations, or relying on specific tax incentives in the US, may be significantly hit by these possible limitations.
What to expect next?
So how should tax reform be expected to play out? Roughly and in order, here are some possible steps ahead before a tax reform bill is signed:
- Congress approves a budget, along with budget reconciliation instructions for tax reform.
- The House acts: it releases and passes a tax bill, converting some version of the House Blueprint into fully operational legislation.
- The Administration acts: it completes its other priorities, including addressing health care reform and releasing a more detailed tax budget.
- The Senate acts: if the bill passes the House by a convincing margin, the Senate will likely follow a similar approach to tax reform. If it passes with only a minimum number of votes, the Senate may pursue its own plans, possibly not based on the Blueprint.
- The bills are reconciled: Congress reconciles differences and develops a compromise bill, which must pass both the House and Senate.
Considering the latest developments, it seems unlikely that a tax reform bill will be passed any time soon. No matter how long the process takes and what the final content is, businesses should not delay in taking action. With the BAT off the agenda, the major concern in terms of the unknown seems to be gone and this is good news. However, foreign and Swiss groups might actually end up being left worse off than under the current tax rules if they use debt heavily to finance their US operations and rely on specific incentives/credit in the US. As an immediate measure, they should continue to follow the developments over the next weeks/months. In parallel and with the help of modeling tools, they should start estimating the impact on their structure and operations, as well as thinking of ways of restructuring their supply chain in order to mitigate or reduce the impact of possible new measures.