The US Senate voted 51-49 on early Saturday, December 2 in favor of the amended tax reform bill. Several amendments and last minute adjustments were made to the original version of the draft bill with a large focus on individual tax or pass through entities. Differences between the House- and Senate-passed versions must now be reconciled. The House on Monday, December 4 is scheduled to vote on a motion to request a formal conference committee with the Senate to negotiate a compromise bill (‘conference agreement’) that would be subject to an up-or-down vote in both chambers before it could be sent to the White House. Even though the Senate discussion was not without bumps, the Senate vote indicates the strong forces and intention to pass US tax reform. It remains most interesting on where the compromise between House and Senate will end.
Both the House bill and the SFC bill respectively the expected reconciled final bill, if enacted, would represent the largest overhaul of the US tax code (the Code) since the Tax Reform Act of 1986.
How are Swiss groups impacted by the proposed legislation?
Foreign groups investing into the US (“US Inbounds”) will be impacted by both the House and Senate bill. It is clear that there is a real effort to meet stated goals of leveling the playing field for US companies. At the same time, some of the proposed rules will, compared to the OECD and BEPS developments, introduce even stricter rules than the ones proposed by BEPS. While the federal corporate rate cut is welcome to Inbounds, there are proposals that could impact cross border transactions negatively. At the same time, the US tax base is enlarged with deduction limitations and new CFC (controlled foreign corporation) and Sub F (rules that require inclusion of certain types of foreign income into US tax base) rules. The Senate and House’s proposals on the excise tax (House) / BEAT (Base erosion and anti-abuse rules – Senate) are of particular concern despite the changes made to the House bill and could impact supply chain and business arrangements with customers. The interest limitation will impact Inbounds in particular the proposed worldwide debt limitations in both bills. Lastly, the revised CFC attribution rules may cause a significant compliance burden in a global group even though a US company may not have any direct or indirect ownership in a related company. Depending on enactment either still this year or early next year, Swiss groups have to be aware that they may have to consider tax accounting and financial reporting measures already for FY 2017.
With Switzerland and Swiss groups being one of the top trading partner with and investor into the US, US tax reform is an important element for Swiss based groups. Nevertheless, the US tax reform and its impact on global value chain and US investments is to be reviewed also considering all other tax and non-tax developments including OECD BEPS, European tax legislation as well as pending Swiss tax reform.
The below is an initial overview on how some of the proposed House and Senate corporate tax rules may impact Swiss companies:
New corporate federal tax rates
Corporate income would generally be taxed at 20% federal rate (US state income taxes of 3% – 8% to be added) and thus, the US becomes more attractive from an international corporate rate perspective. Pending Swiss tax reform would result in an effective tax rate of some 12% – 17% depending on Canton and the US thus closes the gap down from the current 35% US tax rate. At the same time, tax base enlargement rules will come into force resulting in the overall effective tax rate to largely vary on US fact pattern including US domestic versus international footprint of US operation, interest leverage and capital intensity as well as industry. Due to different date of effectiveness, there can be gaps between the rules to enlarge the US tax base and the corporate rate reduction. State taxes would still be applied on top of the 20% federal corporate rate and potential state tax developments are to be monitored separately. Even though the federal corporate rate as such brings the US into a more medium range of OECD average, effective total tax rate may still be higher due to enlarged tax base, CFC as well as Sub F rules and state taxes.
Interest expense deduction limitation / full cost recovery / expensing
Most US group companies have a high level of debt funding. US tax reform would limit interest deduction for both related and unrelated party interest payments requiring companies to review their US based treasury functions and US debt level. The proposed interest limitation rules with the combination of two tests will impose even stricter rules than under the OECD BEPS recommendations and EU Anti-Tax Avoidance Directive. The new rules would significantly impact capital intensive businesses and US operations. Especially the consideration of the financing structure of the entire worldwide group may have a significant impact on the level of US interest deduction. Introduction of anti-hybrid rules would also need to be considered for certain financing structures currently used. At the same time, immediate P&L expensing for investments in certain assets may become immediately and fully tax deductible and may thus replace debt funded acquisition of investments. Swiss groups should thus review their current US funding structure and planned investments into US operations or US acquisitions carefully.
Net operating losses
Limitation of NOLs to 90% of income is planned to be introduced with indefinite carryforward but no carry back. Beside effective use of NOLs in the US, such rule would also require tax accounting considerations and re-assessment of deferred tax asset positions which, depending on enactment, may require a FY 2017 deferred tax position adjustment or a disclosure requirement.
R&D / “IP box”
Current R&D credits will remain applicable and allowance of capitalization and amortization of certain R&D expenditures would be introduced to enhance US R&D activities while some other deductions such as domestic manufacturing deduction would be eliminated. The Senate bill also considers a special rule to encourage transfer of intangible assets to US corporations. A 37.5% deduction (reduction to 21.87% for 2026) would be allowed under the Senate bill for foreign-derived intangible income produced in the US resulting in a 12.5% federal tax rate on such IP income. From an international view, it seems that the consideration of modified nexus approach as defined as the new standard for IP / patent box regimes by OECD BEPS has not been addressed thus far.
Toll charge / participation relief (territorial system) / CFC / Subpart F
Due to the change to a territorial system with a 100% participation regime on foreign dividend income, US shareholders with an interest in a foreign corporation have to include the undistributed, non-previously-taxed foreign earnings. This rule would apply to Swiss groups to the extend they have a US company owning shares in foreign subsidiaries. Such deferred foreign earnings would be taxed immediately at a rate between approximately 7% – 15% depending on the proposal independent whether effectively repatriated or not (deemed mandatory repatriation toll charge). State income tax on such positions are to be considered separately. Further, impact on current tax credit position would need to be reviewed and no more tax credits are applicable in future under the territorial regime. One should however note that the new US tax code as proposed is not a true pure territorial system as most other countries have but would rather overlay the territorial dividend income participation relief to a partial worldwide system with CFC (controlled foreign corporation) and Sub F (rules that require inclusion of certain types of foreign income into US tax base) inclusions. The participation relief on dividends will allow immediate cash flow of foreign earnings back to the US for re-investment, spending or acquisitions in the US. At the same time it is to be noted that participation relief would not apply on capital gains.
With the introduction of a 100% participation relief on dividend income, the Swiss – US double tax treaty withholding tax rate of 5% for dividends will become a final tax charge as no more US tax credits will be possible. Thus owning a Swiss subsidiary through a US company becomes less attractive.
The current CFC and Sub F rules would generally be maintained with some amendments. The new legislation would modify the attribution rules for determining whether a US person is considered a “US shareholder” in connection with determining whether it qualifies as a CFC. The proposed legislation would repeal exceptions so that the foreign subsidiaries (but not the foreign parent) for foreign parented groups with at least one controlled US subsidiary or an interest in at least one US partnership would generally be treated as CFC, even if the foreign subsidiaries are not held, directly or indirectly, under the US entity. Although there may not be an income pick up (provided US entity has no direct or indirect interest) there would be a new reporting requirement for the foreign subsidiaries. Thus, non-US groups have to review CFC qualification and application of Sub F rules as the base for such qualification is extended and new rules introduced for any US subsidiaries. At the same time, new Subpart F categories (foreign high returns or global intangible low-taxed income) would be introduced resulting in a 10% – 12.5% minimum taxation.
Excise tax versus Base erosion and Anti-Abuse Tax (BEAT)
The House bill would introduce a new 20% excise tax for certain deductible payments paid or incurred by a US to a foreign corporation that is a member of the same international financial reporting group. Instead of adopting an excise tax similar to the House bill, the Senate bill would target base erosion by imposing an additional 10% corporate liability (“BEAT”) on taxpayers that make certain base eroding payments to related foreign persons.
From an outside in view, the above two rules can be put into simple words:
- Under the House excise tax approach, the 20% corporate tax rate is levied on gross payments made by a US company (including cost of goods sold, royalties, etc.) to a foreign related person. This is a fairly substantial number in most cases. However, the company has a right to elect out of this gross payment methodology and elect into a deemed US branch methodology with deemed effectively connected income (“ECI”). This largely means the foreign company is taxed in the US on a net income basis with some foreign tax credits on the profit that arises from the US sales outside the US.
- The Senate BEAT approach is simpler in nature by setting a minimum tax approach on “bad” payments to foreign related companies. Bad payments do not including purchase of goods but include interest, royalties or services, etc. to foreign related parties. The base erosion anti-abuse tax is imposed if 10% of the modified taxable income (generally, taxable income without regard to deductible foreign related party payments) of the US corporation exceeds the US corporation’s regular tax liability for the year.
Groups should review the global value chain not only under US tax reform rules but also other international developments including OECD BEPS, EU or Swiss tax law changes.
Hybrid entities / transactions
Other provisions deal with hybrid transactions and hybrid entities and would deny a US deduction for interest and royalties paid or accrued by a US corporation to a related foreign party pursuant to a hybrid entity or hybrid transaction (e.g. non-inclusion or double deductions). This provision may be less relevant for Swiss groups but would require review of certain branch exemptions.
The above changes and rate reduction would impact the deferred tax position under US GAAP and IFRS. If the bill is enacted (President Trump signing the bill) already in FY 2017 such provision is to be accounted for in FY 2017 accounts. In case the bill is signed in 2018, disclosure requirement may have to be considered in FY 2017 reporting already. Thus, modelling the impact on the US tax reform proposals for tax accounting purposes is to be considered. See our PwC blog entry on this topic.
The current draft bills include many changes to individual tax and pass through entities. This may impact US based expatriates on their individual taxation and indirectly Swiss groups under expatriate tax equalization arrangements. Stay tuned for our separate newsletter on individual tax matters.
With the above provisions immediately heading into reconciliation procedure between the House and Senate today, close monitoring of which compromise will be concluded in the final bill is key. What should a Swiss company do today?
- Ensure to know your company’s facts pattern and how US tax reform impacts your company’s holding structure (CFC and Sub F rules), transaction flow, supply and overall value chain (interest deduction excise tax / BEAT implications), cash repatriation or investment plans.
- Do you know whether your company is subject to deemed mandatory repatriation / toll charge tax on US subsidiaries and where the group has untaxed foreign earnings? Acceleration of expenses and realization and use of foreign tax credits should be reviewed. PwC US has developed analytic tools and models to calculate the impact of toll charge as well as other impacts of US tax reform.
- Analyze whether US toll charge is due and if so, whether your groups plans to pay “deemed” tax only or whether an effective dividend shall be resolved up to the US. In case of the latter, are all double tax treaty clearances in place to execute such dividend without adverse withholding tax implications?
- Are you prepared to consider US tax reform in your 2017 financial statements if enacted this year (deferred tax positions, toll charge provision) or do you know applicable disclosure requirements if enacted early next year?
- Communicate with senior management, board of directors or audit committee and engage in US tax reform discussion.
- Stay tuned for the outcome of the reconciliation process and be prepared that US tax reform may be enacted rather sooner than later.
Background and additional reading material
For a detailed explanation of the international provisions of the House bill and SFC bill, please see House passes tax reform bill with international tax provisions
The proposed revisions to US tax code would significantly impact inbound companies, please see PwC Insight for US inbound companies for more details.
For an overview of a high level comparison of the House and Senate bill version see our PwC Blog. As compared to the original Senate proposal, many last minute adjustments have been included into the final draft.
See also our PwC Blog on how US tax reform impacts financial reporting may even for FY 2017.
PwC | Partner on Secondment – Swiss Tax Desk
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