Impact of U.S. Tax Reforms for the U.K.

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Laurence Field

Laurence Field Crowe Clark Whitehill, U.K.

Laurence Field is a Tax Partner with Crowe Clark Whitehill LLP, U.K.

Now that congressional action on the tax reform bill has been completed, what are the potential effects of the U.S. tax reforms from a U.K. perspective?

The U.S. Congress has finally designed an approach to tax reform of the current U.S. system that has passed both houses. At the time of writing, (mid-December 2017) the House of Representatives and the Senate both have their own versions of the proposals, but the Republican Party seems confident the reconciliation process will be successful and a version of the historic reforms will come to fruition.

While internal disputes in the upper echelons of the U.S. government regarding the finer points of domestic tax policy might appear to be of little immediate consequence outside of the U.S., the discussions will have a huge impact on how the U.K. (and the rest of the world) does business with the U.S.

What is Being Proposed?

While the proposed reforms are wide-ranging, from a U.K. perspective, the most relevant appear to be:

  •  an agreement to a 21 percent corporate tax rate (from 1 January 2018)
  •  enhanced deductions for “short-lived” capital investment;
  •  a cap on interest deductions at 30 percent of a measure of earnings (Earnings Before Interest, Taxes, Depreciation and Amortization (EBIDTA) or Earnings Before Interest & Tax (EBIT));
  •  100 percent deductions for dividends received from foreign subsidiaries;
  •  moves to a territorial system of taxation, but with a whole raft of anti-abuse rules and base erosion controls;
  •  deemed repatriation of foreign profits at favorable tax rates;
  •  Reduced tax on foreign-derived income
  •  excise tax or anti-base erosion tax on related-party payments.

What Does this Mean for the U.K.?

Most governments, the U.K.’s included, have been trying to ensure companies remain within their jurisdictions, not only to keep jobs within their respective economies, but also to ensure their tax receipts are not affected. The world's largest economy introducing a 14 percent cut in its tax rate will therefore have a huge impact on these efforts.

Historically, sophisticated U.S. corporates have been able to create structures of overseas subsidiaries of extreme complexity to ensure they pay little additional U.S. tax on their non-U.S. income, at least until the cash comes back into the U.S. It has been estimated that several U.S. $ trillions sit outside the U.S., waiting for an opportunity to be returned onshore.

These funds are often recycled outside of the U.S. into additional foreign investment, though this sometimes has the counterintuitive impact of encouraging U.S. businesses to borrow to pay their domestic dividends. If U.S. groups simplify their structures and invest direct from the U.S., this potentially frees up funds to be directed into research and development (“R&D”) and mergers and acquisitions (“M&A”) in Europe and other economies outside of North America. With the value of pounds sterling worth considerably fewer U.S. dollars than a few years ago, U.S. companies could be eyeing value in the U.K. market. Deal structuring becomes simpler as some of the historic contrivances are no longer worthwhile. The early signs suggest that the stock markets are appreciative of these effects.

The proposals also tax the income of foreign subsidiaries of U.S. companies generated from the use of foreign intangibles at low tax rates. This should encourage U.S. groups to move their intangibles back to the U.S., especially where there is minimal tax on exit in the existing host territory.

Furthermore, the proposals also subject deductible payments made by a U.S. corporation to a related party foreign corporation. While there appear to be thresholds, it will affect large U.K. companies making inbound investments and could affect payments from U.S. parents to their subsidiaries.

The tax reforms could also accelerate the move to tax economic activity in individual countries by global internet giants to ensure individual countries receive their “fair share.” Italy has recently introduced proposals for a digital transformation tax, the recent U.K. Autumn Budget has proposals to tax offshore royalties linked to U.K. sales, and there is already a diverted profits tax in place. To the extent these are revenue-raising measures, they might not be effective if large U.S. companies no longer have an incentive to use low tax jurisdictions for their operations. Finance ministers in Europe have already expressed their concern that the proposals could upset the balance of the tax system.

As for U.K.-based organizations investing in the U.S., there could be an incentive to have more operations across the Atlantic. If the difference between the corporate tax rates is only 3 percent, the sums become easier.

What Should U.K. Companies Do?

Organizations likely to be affected by these proposals should review their existing structures, which will have been designed for a different system. It might be the case that with the changing landscape these structures are no longer fit for purpose, or advantageous to business operations.

Similarly, for U.S. subsidiary companies with U.K.-based operations, the proposals will need to be reviewed, as they could have an impact on company structure.

The way in which the global supply chain works and the capital structures of U.K. companies with U.S. links requires some re-evaluation; some of the proposed taxes could represent a real cash flow cost.

Whatever the impact of the proposals, those organizations with an interest should remain close to developments and prepare as much as possible before these reforms are implemented. With the goal being to sign the bill into law in early January, we can expect a variety of changes to arrive sooner rather than later.

Where there is uncertainty, there is also opportunity. It is vital businesses seek specialist tax advice on what these proposals will mean for their future plans and existing arrangements.

Laurence Field is a Tax Partner with Crowe Clark Whitehill LLP, U.K.He may be contacted at: laurence.field@crowecw.co.uk

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