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Companies awaiting news from Congress about a comprehensive tax overhaul are holding back on tax planning—or are moving ahead cautiously with structures that can be easily reversed.
The House Republican border-adjusted tax flow plan—unveiled in June 2016 but thrust into the forefront after the GOP’s victories in November—could change the playing field of international taxes overnight and reverse decades of aggressive and complex tax planning. After companies have spent years pushing valuable intellectual property offshore, Congress would give them a strong incentive to bring it home.
The change could be a boon to U.S. taxpayers, but also presents a significant risk to those considering tax planning in the months—or perhaps years—while lawmakers debate the legislation.
“What we’re seeing, and what we’re doing, is if there’s a necessity to do something, we’ll try to do it in a way we can modify the structure without detrimental consequences,” said Alan Granwell, of counsel with Sharp Partners PA in Tampa, Fla. “But if there’s not a need to do something now, we’re holding off.”
“Sure, there is a baseline of work that is always ongoing, but the extra stuff is definitely on hold,” said Peter Barnes, a tax law professor at Duke University.
It’s not just a rate cut that companies could miss out on if they create a tax structure that shifts income overseas. The House plan would convert the corporate income tax into a destination-based system by exempting exports and allowing for the immediate deduction of business expenses and labor costs. Royalty payments from IP held in the U.S. would become an exempt export, providing a powerful incentive for U.S. companies to keep their intangible assets home.
In the long term, the plan would almost certainly be a benefit to IP-reliant industries in the tech or pharmaceutical fields. But in the short term, companies that have used transfer pricing and cost-sharing arrangements to shift the foreign rights to IP abroad will be confronted with a tangle as they consider how to unwind years of prior tax planning. Republican lawmakers have provided no clues yet on what aid the law would provide, if any, on the transition.
Companies that may have been considering a cost-sharing arrangement to allocate intangibles offshore face the risk that they’ll pay a high up-front tax cost and see their planned long-term savings erased through the legal changes. Or, the value of the intangibles may appreciate, triggering a tax payment if they are brought home.
“If that transfer of IP carries with it an up-front U.S. tax cost, or other up-front cost, but the planning assumes that the cost will be offset by a benefit in the future—three, five, 10 years down the line—then one should think twice about that kind of planning, because you might end up getting stuck with the up-front cost, and never realize the offsetting benefit,” said Rocco Femia, a member of Miller & Chevalier Chartered in Washington who specializes in international tax matters.
Many practitioners said the situation has essentially put a halt on any tax planning.
“Most of our clients are just waiting to see what does or does not get enacted this year,” said John Warner, a shareholder of Buchanan Ingersoll & Rooney PC in Washington. “It really is hard to do much elaborate or long-term planning in the face of uncertainty.”
In situations where tax planning is necessary for business operations, tax accountants and lawyers are determining the most risk-free options for proceeding. And they are making sure to include an escape hatch.
Granwell said one client creating a foreign affiliate used a licensing agreement for the use of IP. It didn’t provide the long-term tax benefits that a cost-sharing arrangement might—but it could be easily canceled within a year.
The caution comes not only from the proposed tax legislation but also from increased emphasis on business operations and substance in tax enforcement, especially arising from the Organization for Economic Cooperation and Development’s recent project to combat tax base erosion and profit shifting (BEPS).
“The constraints on doing valid cross-border planning have dramatically moved from where they were maybe five to 10 years ago,” Granwell said.
Another vexing issue facing U.S. companies is deciding whether to repatriate offshore earnings. Under the current system, income earned outside the U.S. can be held indefinitely to avoid taxation. The House GOP plan, along with most comprehensive legislative tax proposals, includes a deemed repatriation to bring offshore earnings home at an 8.75 percent tax rate.
For companies considering bringing the cash home anyway, the proposed legislation provides an incentive to wait. But a deemed repatriation might also include tweaks to the use of tax credits for foreign taxes already paid—which would give companies holding those credits a reason to consider repatriating as soon as possible.
The House plan has only been released as an outline so far, leading many observers to keep their ears close to the ground as details slowly come out. One possibility tech companies are hoping for is that the legislation will include provisions allowing them to bring intangibles home without a large tax hit. Such an idea was included in the patent box legislation unveiled by Rep. Neal Boustany (R-La.) and Rep. Richard Neal (D-Ma.), and has been floating around Washington tax policy circles ever since. Neal is now the ranking Democrat on the House Ways & Means Committee, which is leading the tax overhaul effort.
The outline doesn’t currently include specific relief for repatriating IP, nor could taxpayers count on lawmakers to cover all possible repercussions of the shift in IP location. And the politics of it—an IP repatriation alongside an income repatriation, which could be seen as a tax cut to wealthy tech and pharmaceutical firms—are anyone’s guess.
The legislative process on a tax overhaul could be measured in months—or years. The longer companies wait, the harder it will be to put off decisions about tax planning, according to practitioners.
“This delay can’t last forever,” Barnes said.
“By summer 2017, companies will have to make decisions” on issues such as repatriation, restructurings, and in response to mergers, he said.
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