US tax reform impacts inbound foreign companies6 June 2019
As 2017 ended, the United States (US) government implemented a sweeping tax reform that impacts non-US companies doing business in the US. If you do business in or operate a subsidiary in the US, here are some key changes to consider:
Reduced corporate tax rate
The US has been well known as having one of the highest corporate tax rates in the world. Effective January 1, 2018, the US corporate tax rate changed from 35 percent to 21 percent. Many multinationals are considering whether prior earnings stripping and transfer pricing strategies may need to be evaluated due to this change.
Foreign derived intangible income
For US companies that have sales to foreign customers, a new tax incentive is available which allows for a deduction of 37.5 percent for qualifying sales. This deduction results in an effective rate of 13.125 percent and has the potential to reduce state taxes as well. Qualifying sales include unrelated and related party sales of property for foreign consumption and services provided to persons or with respect to property located outside the US. To qualify, the qualifying foreign income needs to exceed 10 percent of the US corporation’s qualified business asset investment (fixed assets). Many foreign companies are considering whether to shift activities to the US to reduce the effective tax rate on such income.
Interest deduction limitation
Foreign parented US companies were previously subject to an interest deduction limitation when interest payments were made to a related party and the debt to equity ratio of the US company exceeded 1.5 to 1. Due to tax reform, the interest deduction limitation applies to companies with gross receipts over US$25 million. The limitation applies to all interest, whether paid to related or unrelated parties, and is generally the excess of the total of a) business interest income b) 30% of the US company’s Adjusted Taxable Income and c) floor plan financing. Companies that utilize leverage need to evaluate the impact of this change and the need for potential changes to their capitalization strategy.
Base Erosion and Anti-Abuse Minimum Tax (BEAT)
US Corporations who have average annual gross receipts of US$500 million for the prior three years may be subject to a minimum tax of 10% (12.5% after 2025) on intercompany payments. The BEAT will apply if the total deductible payments made to related parties is 3% or more of deductible expenses and the minimum tax exceeds the regular tax liability. Companies with significant intercompany payments may need to evaluate supply chain and transfer pricing strategies in light of the BEAT.
Sale of US partnership interests
As part of tax reform, the US government codified their view that the sale of an interest in a US partnership by a foreign person should be considered US effectively connected income (ECI) and subject to US taxation. In addition, they implemented a mandatory 10 percent withholding tax on the disposition of a US partnership interest by a foreign partner. Foreign partners operating as a partnership or joint venture should consider this change in planning their exit strategy.
By Shannon Lemmon, International Tax Partner, HLB USA