Many believe the massive US tax reforms ushered in by the Tax Cuts and Jobs Act (TCJA) — including its cross-border measures — are mainly the product of the Trump Administration. But for years before this Administration came to power, forces inside and outside the US were propelling the country toward potentially transformational tax policy change.
Correcting a perceived imbalance in the global playing field
Before the TCJA’s introduction in 2017, 30 years had passed since the US tax system had undergone any significant change. As globalization spread during those decades, many US multinationals came to believe the international tax system was tilted against them. As a result, in their view, the country’s tax base was eroding and its tax competitiveness was declining compared to its key trading partners.
By the time of presidential and congressional elections in 2016, the US had the highest corporate tax rate among member countries of the Organisation for Economic Co-operation and Development (OECD). The rising number of corporate tax inversions and intellectual property migrations was raising economic and other concerns within the US. Meanwhile, other countries were demanding a larger share of tax from the profits earned by US companies within their borders.
By 2016, a movement to reform the US tax system was already strong, and work on these reforms in the Senate and House of Representatives had been underway since at least 2011. The 2017 bill resulted from a hard-won consensus firmly enabled with the arrival of the Trump Administration after 5 or so years of policy development and debate. The changes the Administration inspired largely involved bill’s high-level features, like the reduced 21 percent corporate tax rate, which were negotiated to avoid a presidential veto and ensure the bill’s passage.
The Administration shared the objectives of the legislative branch’s overarching design, however. The TCJA’s international tax reforms sought to restore equilibrium for the US vis-à-vis other countries. With the bill’s lower corporate tax rate and other reforms, many believe the US is more competitive relative to its major trading partners than it was before.
Cross-border tax measures: the TCJA’s six pillars
The TCJA is huge and covers all types of taxes, including those imposed on individuals and domestic businesses. Despite its sprawling scope, the bill’s measures are interconnected and designed as a package to enable tax changes amounting to over $10 trillion US dollars (USD). The bill’s cross-border tax measures reflect this holistic approach. The TCJA’s international tax reforms are structured across six pillars, with each pillar providing an essential support for the overall design.
- 21 percent rate: The TCJA’s centerpiece measure brings the US rate more in line with those other OECD countries, putting the US in the lower-middle of the pack. While the Trump Administration might have preferred to see the rate go as low as 15 percent, the 21 percent rate was determined to be the lowest achievable rate.
- Participation exemption: This measure is consistent with incentives commonly offered by other industrialized countries and aims to encourage companies earning income through subsidiaries outside the US to repatriate their foreign earnings tax-effectively. The one-time mandatory repatriation tax was a transitional measure aimed at US companies that had been keeping their profits offshore to avoid the 35 percent US corporate tax rate.
- Global intangible low-taxed income (GILTI): This tax on certain income earned outside the US generally taxes US shareholders on their portion of a controlled foreign company’s global intangible low-taxed income by establishing a new current inclusion regime similar to Subpart F.
- Foreign derived intellectual property income (FDII): The GILTI regime’s preferential rate may create an incentive to take income offshore, so the FDII rules provide a countermeasure that allows a similar preferential rate for income earned inside the US from sales, rentals and licenses of property or provision of services for use outside the US.
- Base erosion and anti-abuse tax (BEAT): This anti-base erosion measure for inbound investment stops companies from using related-party transactions to strip income out of the US through the use of certain so-called “base erosion payments” by imposing a corporate minimum 10 percent tax.
- Interest limitation: Also designed to prevent base erosion, this pillar aims to address perceptions that the US’s longstanding deduction for interest payments was creating a preference for debt financing over equity financing, leading to excessive leverage and risk.
Each pillar is integral to the whole cross-border tax reform package. The 21 percent rate and participation exemption improve competitiveness. The GILTI and FDII encourage foreign profit repatriation and discourage shifting profits offshore. The BEAT and interest limitation round out the package with measures that tackle avoidance and abuse, intending to level the playing field for US versus other companies. If you eliminate one pillar, the system becomes unstable.
Linked rates: a mechanism for future-proofing?
TCJA’s legislative authors designed the law package to withstand potential attempts by future administrations to alter the headline 21 percent corporate tax rate or the other TCJA pillars for short-term tax revenue gains. By law, the other rates in the package are set as a percentage of the headline rate. That means an increase to the 21-percent rate automatically causes an increase in the other rates, potentially undoing what the other pillars are meant to achieve.
If you raise the preferential GILTI rate to match the corporate rate, for example, US companies could plan to escape the US tax net altogether, in search of lower tax jurisdictions. Similarly, if you raise the FDII rate, companies would have more incentive to move their profits to lower-taxing jurisdictions.
Of course, no law is immutable. In the future, the cross-border reforms could be affected by actors inside and outside the US.
For example, the FDII is highly unpopular outside the US and is seen by some as an illegal export subsidy. The World Trade Organization (WTO) has not made a determination on this issue. While it may be unlikely that the WTO would challenge a measure so central to the policies of the Trump Administration, that does not close the door on a potential WTO challenge to the FDII in the future.
Within the US, the 2020 presidential and congressional elections could also set the conditions for amendment or repeal. The TCJA is a creation of the Republican congressional majority at the time combined with the arrival of a Republican president; not a single Democrat voted in its favor.
But no matter how the 2020 election turns out, companies doing business in the US are unlikely to see a corporate tax rate increase or other significant cross-border tax amendments in the near term. TCJA’s entangled pillars are meant to deter quick changes. The TCJA took Republicans 6 years from start to finish and were finally enabled as a result of the 2016 elections.
Takeaways for tax leaders
For today’s tax leaders, the TCJA’s USD10 trillion worth of tax changes comprise what is likely the largest tax measure we may see for decades, in the US or worldwide.
Whatever the future may hold where US tax reform is concerned, tax leaders can prepare their teams and their organizations by:
- examining current US business models, holding structures, supply chains and financing arrangements in light of the TCJA’s changes, especially as the volume of implementing regulations — currently at about 2,600 pages1 and climbing — continues to mount
- keeping a close eye on US and international tax policy developments, as well as broader geopolitical trends so they can be ready for the new strategic and operational challenges they will face in the short, medium and long terms
- undertaking detailed scenario planning to develop their responses to the full spectrum of possibilities, including a potential US corporate tax rate increase in the middle or longer term.
Principal in Charge, Federal Legislative and Regulatory Services
KPMG in the US
Principal, Federal Legislative and Regulatory Services
KPMG in the US
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1 This page count is based on the version posted on the Internal Revenue Service website (not the Federal Register).