Congress on December 20 gave final approval to the House and Senate conference committee agreement on tax reform legislation (HR 1) also called “Tax Cuts and Jobs Act” that would lower business and individual tax rates, modernize US international tax rules, and provide the most significant overhaul of the US tax code in more than 30 years.
The only remaining uncertainty is whether President Trump will sign the legislation into law before the end of this year, or if the signing might be delayed until January 2018.
The final conference committee agreement for HR 1 (the ‘Conference Agreement’ or the ‘Agreement’) will lower permanently the US federal corporate income tax rate from 35 percent to 21 percent. The Conference Agreement will further temporarily reduce the current 39.6-percent top individual income tax rate to 37 percent and revise other individual income tax rates and brackets. Both the new corporate tax rate and revised individual tax rates shall be effective for tax years beginning after December 31, 2017. The Agreement will repeal the corporate alternative minimum tax (AMT), while retaining a modified individual AMT with higher exemption amounts and phase-out thresholds.
In short, the Conference Agreement provides for the most significant overhaul of US international tax rules in more than 50 years by moving the United States from a ‘worldwide’ system to a 100-percent dividend exemption ‘territorial’ system. As part of this change, the Agreement includes two minimum taxes aimed at safeguarding the US tax base from erosion, along with other international tax provisions.
The Agreement further includes a broad range of tax reform proposals affecting businesses and individuals, including a new 20-percent deduction for certain pass-through business income. In addition, the Agreement repeals or modifies many current-law tax provisions to offset part of the cost of the proposed tax reforms. The Joint Committee on Taxation (JCT) staff have estimated that the net revenue effect of HR 1 will be to increase the on-budget federal deficit by $1.456 trillion over 10 years.
Highlights of the US tax reform bill
The final US tax bill appears to attract investments, jobs and business in the US and increases the attractiveness of the US by introducing a 21% federal income tax rate, participation relief on foreign subsidiary dividend income (though not on capital gains) or an incentive for US production for sale to “foreign” customers (Foreign Derived Intangible Income – FDII). On the other hand, the above benefit come with a toll charge tax on foreign untaxed profits of US controlled foreign companies (CFCs) and many new rules that enlarge the US tax base such as interest deduction limitation, a new Base Erosion Anti Abuse Tax (BEAT), expanded controlled foreign company (CFC) definitions and new foreign profit inclusion (Sub F) rules such as the global intangible low-taxed income (GILTI) and the anti-hybrid rules.
One can for sure say that cross border group transactions with the US become more complex. So do US compliance and reporting obligations, which especially for non-US groups increase significantly. The Trump campaign planned to create an easy and simple US tax code under which the US tax return should have the format of a “postcard”. Though the new rules will significantly increase the complexity. The final US tax legislation also has international discussion potential as WTO and EU already address incompatibility concerns for the new BEAT and FDII rule. The US tax reform as passed should be reviewed carefully in international context or unilateral reactions and measures as well.
The new rules are complex and impact of the US tax reform is to be reviewed on a case by case basis by every company. For a detailed summary of HR1 rules, see PwC Tax Insight
What to do now?
While the new tax legislation wording may not be precise in all details or results in unintended consequences, treasury and IRS now have to present underlying regulations and practice notices as guidance for application and interpretation. Such details are only expected to become available over the next weeks and months.
The immediate implication of the US tax reform is however its impact on 2017 financial reporting and tax accounting. For both, US GAAP and IFRS the enactment date is the signing date by President Trump. Accordingly, in case of signing in 2017, respective tax accounting entries and in case of signing in 2018, disclosure requirements need to be considered for the financial statements 2017.
Relevance of the US tax reform for Swiss companies and economy
The US tax reform will increase global tax competitiveness for US business. Switzerland and the US have very strong trading relations. With USD 224 billion of cumulative direct investments, Switzerland is the 7th largest investor into the US. Many Swiss companies have a significant US footprint either by US manufacturing or with sales and distribution functions or services rendered and are impacted by the new legislation as the US is an important export market. On the other hand, Switzerland is also a key trading partner of the US as it is the 7th largest export market for services, the 17th largest for goods and is an important location for European headquarters of US multinational groups. Switzerland as well as Swiss companies will thus for sure be impacted by the US tax reform.
The most important considerations from a Swiss perspective:
- Review global supply & value chain as well as pricing approaches considering the new foreign profit inclusion and anti-base erosion rules
- Review US funding and investment & acquisition plans considering the interest limitation rules and expensing rules
- Increase of international tax competitiveness for US business and Switzerland
- Review international and Swiss tax developments in the light of US tax reform
The rules in more detail
HR 1 is proposed generally to be effective for tax years beginning after 2017. Certain provisions have separate effective dates, while others are effective after the date of enactment and some are effective for tax years beginning after 2016. The bill also proposes some temporary measures and provides transition rules for certain proposals. The below summarizes the most important general provisions. Many exemptions and special rules however exist for specific facts or certain industries in the more than 500 pages of tax legislation that are to be considered in detail on a case by case basis.
Corporate rate reduction
The current 35% top federal corporate rate is reduced permanently to 21% for tax years beginning after 2017. The current corporate alternative minimum tax is repealed. State taxes are to be added and thus the combined US tax rate will be in average around some 26%. This rate will still be slightly higher than the 23.75% average rate for all other OECD nations in 2017.
Tax location competition for Switzerland will increase not only with the US but especially also the EU to attract US business. Passing Swiss tax reform is an important measure to maintain Switzerland’s competitiveness and business location attractiveness.
Interest expense limitation
Interest expenses both for related and unrelated party debt is limited to the sum of business interest income plus 30% of the “adjusted taxable income”. Adjusted taxable income is defined similar to EBITDA for taxable years beginning after December 31, 2017 and before January 1, 2022, and is defined similar to EBIT for taxable years beginning after December 31, 2021. Disallowed interest is allowed to be carried forward indefinitely.
US companies are typically highly debt leveraged under today’s rules favoring debt over equity. Accordingly companies should reconsider the US operation’s funding structure in detail.
Cost recovery / full expending of certain property
100% full expensing for investments in new and used property made after Sept. 27, 2017 and before January 1, 2023 is introduce. A five-year phase down of full expensing will begin in 2023.
This rule intends to attract investments into the US. Swiss groups that plan investments into the US should (re-)consider the funding and expensing of US investments as well as timing of planned investments under this rule.
NOL’s / Tax loss carry forward
NOLs are limited to 80% of income for losses arising in taxable years beginning after December 31, 2017. Indefinite carryforward but no carryback for losses arising in taxable years ending after December 31, 2017 will be applicable. For insurance companies special rules will apply.
Companies with tax loss carry forwards in the US will need to assess the impact on deferred tax positions for financial reporting purposes. In future, companies with NOLs will have to pay US cash tax in years with taxable profit as only 80% of income per year can be set off with NOLs.
R&D Credit / Domestic Production Credit
The R&D credit as per the current rules remain in place to maintain the jobs and attractiveness of the US for research and development activities. This measure combined with the new “foreign derived intangible income” rule shall increase the attractiveness to keep intangible property in the US. On the other hand, domestic production credits for taxable years beginning after December 31, 2017 are repealed.
Participation Relief and Toll Charge Tax
A territorial tax system providing a 100% dividends received deduction (DRD – participation relief) for certain qualified foreign-source dividends (10% shareholding and 1 year holding period required) received by US corporations from foreign subsidiaries is introduced effective for distributions made after 2017.
The territorial system is introduced only for foreign dividends while for any other activities, the current CFC (controlled foreign company) and Sub F (inclusion of CFC foreign profit for US taxation) is maintained.
Under DRD, no more tax credits are available for dividend income. From a Swiss perspective, dividends from a Swiss subsidiary to a US parent are subject to Swiss withholding tax resulting generally in a 5% residual Swiss withholding tax under the Swiss – US double tax treaty. Any foreign withholding tax will become a final tax cost as no more tax credit available in the US.
As a consequence of the change to a territorial tax system, previously untaxed foreign earnings of US CFCs (foreign subsidiaries of US companies) are subject to repatriation toll charge tax at 15.5% for cash & cash-equivalents and 8% on non-cash assets. Such toll charge tax will be payable over 8 years.
Any US company owning shares in foreign subsidiaries will be subject to the toll charge tax resulting in an immediate impact on its tax accounting and financial reporting.
Expanded CFC definition and new Sub F Rules
In general, the current CFC (controlled foreign companies) and Subpart F rules (inclusion of foreign CFC’s profit into the US tax base) are generally maintained. Under the current CFC attribution rules, foreign subsidiaries of non-US parented groups that are not held by US entities are not treated as CFCs. Under the new expanded CFC definition, if a non-US parented group has at least one US subsidiary or an interest in a US partnership, any other non-US subsidiary would generally be treated as CFC. Although there would be no income pick up or attribution of profit to US tax base as long as the US entity does not have a direct or indirect interest in such foreign entities. However, there may be a reporting requirement (reporting 5471) for all of the foreign entities under the non-US parent. Such expanded CFC definition is effective the last taxable year before January 1, 2018 (effectively already for 2017).
Under these rules, a Swiss parent group that owns one US subsidiary would have a tax reporting duty in the US for all its subsidiaries.
The new tax code also adopts a deduction for ‘foreign derived intangible income’ (FDII) and the global intangible low-taxed income’ (GILTI) provisions, as well as the ‘base erosion and anti-abuse tax’ (BEAT).
The BEAT targets US base erosion payments from US companies to any group entities abroad resulting in higher US taxes. The intention of such rules is to create an incentive to provide such activities in the US rather than “outsourcing” to non-US group companies and avoid base erosion payments. The US base erosion with payments of interest, royalties or other transfer prices such as management fees, services etc. should be limited. A big relief for many Swiss companies is the fact that the BEAT does not include payments for costs of goods sold (except for former US groups that inverted abroad). A Swiss company selling goods to US customers directly or via a US distribution company should not be adversely impacted.
The BEAT is a new add-on minimum tax that is imposed in addition to the corporate tax liability. Subject to BEAT are generally corporations with average annual gross receipts of at least $500 million and that make certain base-eroding payments to related foreign persons for the taxable year exceeding 3% (2% for certain banks and securities dealers) of all their deductible expenses.
The BEAT is a comparable calculation and the additional tax is imposed if
(i) 10% of taxable income (5% in 2018 and 12.5% for tax years after 12/31/2025, 6% for certain banks and securities dealers) generally determined without regard to amounts paid or accrued to a foreign related party (other than COGS and certain services), including amounts includible in the basis of a depreciable or amortizable asset;
(ii) regular tax liability (consideration of available credits apply based on specific rules).
The BEAT of $1 is levied on top of the regular US tax charge of $21.
The BEAT will result in higher taxes in the US and impacts Swiss groups rendering services, licensing intangible assets or financing activities to US group companies. Swiss groups as well as US multinational groups need to review the cross border value chain and transaction flows to assess the extra US tax to become due under the BEAT.
From an international point of view, the BEAT is not undisputed and both the WTO and the EU have addressed to the US government concern whether such tax is permitted under international trade and double tax treaty rules. Further expert assessment is expected. In case deemed to be a concern, potential international counter measures might result.
Foreign derived intangible income’ FDII) and global intangible low-taxed income’ (GILTI)
The FDII should create an incentive to keep the IP in the US for domestic production in the US and sale of goods and services abroad by allowing a 37.5% deduction on foreign-derived intangible income from a US trade or business. The deduction is reduced to 21.875% for taxable years beginning after 12/31/2025.
Income eligible for such deduction would be taxed at a 13.1% effective tax rate (21% federal tax less 37.5% deduction) effective for tax years beginning after 2017.
Such rule is comparable to a patent / IP box and shall intensify to keep and relocate IP to the US. The US legislation is silent on modified nexus approach as defined as OECD and EU standard and thus, such rule also triggers discussion on an international level for compatibility with new OECD BEPS international standards. While it appears to be a benefit to transfer IP into the US, Swiss groups should consider such a step carefully also in the light of sustainability of US tax legislation as well as future US exit taxes and the overall value chain and operational set up. For location Switzerland, this means that US companies have less of an incentive to transfer IP abroad. To assess the most competitive IP and business location, any of the existing and new rules as well as international developments should be considered holistically to assess overall pros and cons. Especially the combination with any other base erosion and US tax base enlargement rule and the comparison of tax impacts on a holistic basis may differ significantly from case to case.
The GILTI introduces a new Subpart F category in which US shareholders of CFCs become subject to current US tax on “global intangible low-taxed income”. GILIT is defined as income in foreign CFCs that generate a 10% margin or more on certain products. If so, such profit of CFCs exceeding the 10% margin is to be included in the US tax base under consideration of a 50% deduction and an 80% foreign tax credit.
The GILTI rule will only impact structures where a US company owns foreign subsidiaries. As long as the US subsidiary however does not own any shares or partnership interests in foreign entities, such rules would not apply. Thus a Swiss group that holds a US distribution or manufacturing subsidiary, which itself is not invested in foreign entities should not be impacted by GILTI. Considering the 80% foreign tax credit that is available in the GILTI calculation, GILIT tax is as an approximation only expected to result in an additional tax burden if the foreign tax rate of the CFC is below 13.125%.
New anti-hybrid rules inspired by the OECD BEPS rules are introduced. Accordingly, a US company will not be allowed a tax deduction in the US for interest or royalty payments if the income is not taxed or results in a double deduction in the recipient’s jurisdiction. This rule applies to hybrid entities or hybrid instruments and also applies to the newly introduced US participation relief. Since the rule largely follows OECD BEPS wording, further explanations, on how the rule will be applied in detail, are expected to be included in upcoming IRS and Treasury regulations and practice notices.
Accordingly, any payment of US companies have to be reviewed whether paid to a hybrid entity or whether the instrument as such is qualified as hybrid.
The US tax reform covers federal income tax. How and at what point in time the States adopt the new US tax code matters is unclear at this stage. Companies should carefully monitor State tax interactions under the new rules as well.
Individual Tax Matters
The US tax reform legislation includes many rules for individual tax payers and aims to reduce the tax burden for low and middle calls families. However, the rules are highly complex and impact depends literally on very specific individual facts which define allowed deductions, incentives and applicable tax rates. Whether you are a winner or not so lucky individual tax payer under the new rules has to be assessed personally.
The following shows a few of the important provisions that will impact individual taxpayers living and working abroad.
The following rules do not change and continue to apply:
- US citizens and residents taxed on worldwide income
- 409A rules (Nonqualified Deferred Compensation Plans)
- Taxation of nonqualified stock options at exercise
- Net investment income tax
- 401(k), qualified plan pre-tax contribution limits
- Foreign earned income exclusions for taxpayer living and working abroad
- Foreign tax credit rules
- Gift tax
- Qualified dividend and Capital gain rates and holding periods
- Charitable contribution deduction
The following rules will change:
- Standard deduction increase to $24K for married taxpayers
- Limit on property tax deduction, combined with state and local tax deductions to $10K
- Mortgage interest deduction, limited to $750K including the repeal of deduction on home equity indebtedness
- Relocation costs paid directly to the vendor by an Employer may become taxable to the employee
- Increase in lifetime estate and gift tax exemption to $11M per donor
- Sale of US Partnership interest by a foreigner is considered US effectively connected income
- Taxation of income from tax-transparent entities (i.e. LP, LLP, LLC) at the entity level rather than the individual owner, except for certain personal services businesses
- Increase of the current AMT exemption
- A ‘toll tax,’ which would subject certain individuals and trusts to a one-time reduced tax on the undistributed foreign earnings and profits (E&P) in US-owned foreign corporations.
Depending on your personal tax situation, there are certain actions you may take before the end of the year to benefit from the existing provisions that are subject to change or that are expected to be completely repealed from the tax code.
Questions & How can PwC help you?
PwC would be pleased to assist you with:
- Any questions on how the US tax reform may impact yours and your company’s US tax position;
- Assist with modelling US tax reform impact. PwC has developed specific financial modelling tools;
- Support you for any tax accounting questions for your financial report;
- Support assessment of global value chain and US related business transactions;
- Follow our publications and blogs via:
- PwC will present a series of webcast in January 2018 explaining several of the new rules in more detail
- Our US experts are available for individual meetings and discussions upon request.
Corporate and business tax
PwC | Partner – International Tax Services
Office: +41 58 792 68 84 | Mobile: +41 79 286 60 52
Birchstrasse 160, 8050 Zurich
PwC | Partner, International Tax Services
Office: +41 58 792 44 82 | Main: +41 58 792 44 00
Birchstrasse 160 | Postfach | CH-8050 Zürich
PwC | Partner, International tax services, Central Cluster ITS Leader
Office: +41 58 792 97 18 | Mobile: +41 79 652 14 77
Avenue Giuseppe-Motta 50 | Case postale | CH-1211 Genève 2, Switzerland
PwC | Partner on Secondment – Swiss Tax Desk
Office: +1 646 471 14 01 | Mobile: +1 917 459 8031
300 Madison Avenue, New York, NY 10017
Richard Barjon, CPA
PwC | Director
Office: +41 58 792 13 53 | Mobile: +41 79 419 55 16
Birchstrasse 160 | Postfach | CH-8050 Zürich