Top 2 issues of the new tax reform legislation for global companies doing business in the United States

After months of talking at length about planning for and the potential effect of US tax reform on your global business in the United States, we finally have two long-anticipated tax reform bills. The Tax Cuts and Jobs Act (HR 1) approved November 9 by the US House Ways & Means Committee, proposes to lower business tax rates to 20% (25% for certain 'pass-through' income), modernize US international tax rules, and simplify the tax law. Also on November 9, Senate Finance Committee Chairman Orrin Hatch (R-UT) released his version of a tax reform bill (the Hatch Bill).

There are two proposals found in each bill to which non-US companies operating in the United States should pay particular attention: the new excise tax and the net interest deduction limitation.

1) Excise/base erosion tax proposal. Under HR 1, payments (other than interest) made by a US corporation (and a foreign corporation’s US branch) to a related foreign corporation that are deductible, includible in cost of goods sold or includible in the basis of a depreciable or amortizable asset would be subject to a 20% excise tax, unless the related foreign corporation elected to treat the payments as income effectively connected (ECI) with the conduct of a US trade or business.

The Hatch bill creates a ‘base erosion tax’ which would apply after 2017 to taxpayers with annual average gross receipts of at least $500 million over the preceding three years. This tax is equal to the difference between 10-percent of taxable income (grossed up by certain deductible payments to foreign related persons) and taxable income (reduced by certain credits). The base erosion and anti-abuse tax under the Hatch bill has the same policy objectives of the House excise tax but addresses the issue differently.

Why do you care? Either proposal would impose a new, sweeping US tax on certain deductible payments made to a related foreign party, and is expected to have a significant adverse effect on multinational groups. This is especially important for companies that import parts or manufactured products from affiliates outside the United States, have intellectual property held by a foreign affiliate, or have principal structures based outside the United States.  

If enacted, this proposal potentially could disrupt the supply chains of many global companies as it relates to cross-border business transactions that such corporations routinely make between related entities. In addition, issues would arise whether the proposal could be seen as violating internationally accepted principles of nondiscrimination contained in virtually all US income tax treaties and US treaties of friendship, commerce, and navigation.

2) Interest expense deduction limitation. HR1 would provide two new sets of rules for limiting interest deductions.  The first limitation generally would limit US net interest expense deductions to 30% of adjusted taxable income, roughly equivalent to earnings before interest, taxes, depreciation, and amortization (EBITA). The second limitation would limit the interest deduction of a US corporation (and foreign corporation with US business) that are part of a large multinational group (i.e., groups with consolidated/audited financial statements and average gross receipts in excess of $100 million). The provision would in effect limit the interest expense deduction to the extent the US corporation’s share of the group’s global net interest expense exceeds 110 percent of the US corporation’s share of the group’s global EBITDA.

The Hatch bill also contains two similar limitations, but differs significantly in its computation of the deduction limitation and its carryforward rules for disallowed interest expense.  

Why do you care? The deduction for net interest expense is important to both US and non-US companies as it affects the way many businesses operate and how they are financed. The proposal generally would result in a broad limitation on interest deductibility for many types of domestic and global businesses that incur indebtedness.  The provision would require global taxpayers to determine the amount of their interest income and interest expense that is allocable to investment activities versus business activities. Many businesses typically do not distinguish between investment and business activities. Consequently, this may create complexity, compliance burdens, and controversy.

So what steps can you take? As you model and plan for tax reform, keep in mind that many of these provisions will continue to evolve throughout the legislative process.  The House and Senate bills have similar policy objectives – to boost US competitiveness and productivity through lower business tax rates, a modernized international tax system, and incentives to invest in the United States – but differ in many specific respects and will need to be reconciled before tax reform can be enacted. As a result, more changes are to be expected and US Inbounds should stay abreast with the changes as they occur.

For more details, read PwC's Tax Insights, Overview of Ways and Means Chairman Brady’s tax reform bill, House Ways and Means Committee approves amended tax reform legislation, and Finance Committee Chairman Hatch releases Senate tax reform bill.

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