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By Ben Stupples
Multinational companies are grappling with complex issues following passage of tax reform in the U.S.
The 2017 U.S. tax act and the OECD’s project to curb corporate tax avoidance are forcing global businesses to reassess their finances. Bloomberg Tax reported March 8 that U.K.-listed companies alone face almost a $1 billion tax charge through a one-off U.S. levy on multinationals’ overseas earnings.
Bloomberg Tax asked Melissa Geiger, KPMG LLP partner and head of international tax in the U.K., about the international tax issues facing multinational companies. Geiger rejoined KPMG in October after three years as global head of tax at GlaxoSmithKline Plc, the FTSE 100 pharmaceutical business. In 2008, before moving to GSK, she became KPMG’s youngest female equity partner.
KPMG is already seeing “large impacts” for multinational business in response to the new U.S. tax law, Geiger told Bloomberg Tax in a written Q&A. In addition, she highlighted the possible long-term impact of U.S. tax reform on global companies and identified how businesses should respond to the country’s new intangible income regime.
Due to the reform, companies are having to “become familiar with a new set of tax jargon,” she said.
This is part one of a two-part interview.
Bloomberg Tax : FTSE 100 businesses are still assessing the immediate impact of the new U.S. tax law on their finances, largely through changes in the value of their deferred taxes. Beyond this preliminary stage, what are the key issues that multinational businesses outside the U.S. need to consider about U.S. tax reform?
Geiger: Since U.S. reform was enacted, most companies have been busy assessing the immediate financial statement impacts. Having got through that initial hurdle, we are now seeing business giving thought to the wider implications of U.S. reform, both in terms of risks and opportunities.
Without doubt the reform is wide reaching and there are still areas where there is a lack of clarity. We expect to see the IRS issuing guidance over time but, in the meantime, businesses are having to draw their own conclusions.
There is no one-size-fits-all answer to the question of how to respond to U.S. tax reform. There are no clear sector winners or losers. Each business is having to assess reform against their own fact pattern. What we are seeing, however, are some key themes or areas of interest emerging.
The first is capital structure. Going forward the deductibility of interest expense will be significantly limited and most companies will now need to look at the capital structure of their U.S. operations. The legislation generally limits net business interest expense to 30 percent of EBITDA for taxable years before 1 January 2022 and thereafter to 30 percent of EBIT. The calculations of EBITDA and EBIT are tax rather than financial accounting based and not exactly the same as in the U.K. but do give an approximate yardstick.
Historically, the high historic tax rate and comparatively generous interest deductibility in the U.S. has tended to encourage multinational groups to leverage that jurisdiction and benefit from a tax rate arbitrage between the U.S. and the lending jurisdiction.
The rate cut already reduces, and in some cases may reverse, that picture. The interest limitation will deepen the impact. Those that are highly leveraged into the U.S., such as capital intensive businesses that do not qualify under the real property trade or business exception will be most impacted by these changes and will be reassessing their capital structures.
The second area is the BEAT tax which affects large businesses with material inter-company financial flows or royalty payments.
The BEAT, or Base Erosion Anti-Abuse Tax, essentially applies a 10 percent minimum tax to taxable income as adjusted for base erosion payments. The tax only affects businesses where gross receipts derived by U.S. companies and U.S. branches are in excess of $500m (aggregated on an expanded group basis) and so has limited application for multinational groups without a significant U.S. presence. In addition, costs of goods sold (COGS) are generally excluded from the definition of base erosion payments. So, for example, a U.S. business that imports product for manufacturing and/or resale is likely, on the face of it, to be less affected by the new rule than a services company.
However, in practice, we are seeing some large impacts for multinational groups, especially where they use non-U.S. intermediary group companies as the central principal company(ies) for third party contracts and, therefore, have U.S. outbound related party financial flows to such intermediary companies. Many companies are beginning to look at whether these third party contracting arrangements should be restructured and if the U.S. companies should enter into direct contracting relationships with third party suppliers.
Bloomberg Tax : How do you expect the U.S.’s new laws aimed at intellectual property and intangible income, the Global Intangible Low-Taxed Income (GILTI) and Foreign-Derived Intangible Income (FDII), to change U.S. multinational companies’ international tax planning this year?
Geiger: The introduction of new laws aimed at intellectual property and intangible income, GILTI and FDII, means that businesses have to become familiar with a new set of tax jargon. What’s interesting is the interplay between these measures, and the carrot and stick approach U.S. policymakers have adopted throughout the reform that is intended, effectively, to repatriate activity and jobs to the U.S.
FDII (foreign-derived income attributable to intangibles) is effectively offering a beneficial tax regime to U.S. businesses that derive ‘export’ income. It applies to taxable income in excess of a 10 percent return on certain tangible depreciable property (i.e., preference for income attributable to ‘non-tangible’ property).
The rules are complex but broadly apply a deduction of 37.5 percent on income (until 2026) meaning that the end result is an effective U.S. tax rate of 13.125 percent on such income (compared to the headline tax rate of 21 percent).
This is clearly designed to incentivize companies to either develop or move more IP to the U.S. This measure could be seen to be very generous, maybe even too generous by the OECD and WTO. It effectively has the potential to give tax benefits that reach beyond pure intangible income as the formula for this preference means any return in excess of a fixed amount of 10 percent on tangible assets is deemed to be attributable to intangibles, without the IP development substance requirements prevalent under other IP tax-preferenced regimes. This makes the rules fairly arbitrary and arguably more generous than the patent box regimes in the U.K., Spain and Italy. As such, it means business will look seriously at new IP investment in the U.S. for the first time in decades.
However, there is a flipside. First there is a complex interaction with BEAT meaning that there is a concern that certain IP repatriation transactions into the U.S. (which is the intent of the policy) could trigger a BEAT charge. This might be significant enough to discourage moving IP into the U.S. And secondly, there is now a minimum tax on foreign earnings deemed received by US-based corporations from intangibles—the newly named GILTI tax.
The GILTI is another anti-base erosion measure that is causing a lot of interest. The measure targets U.S. corporations that own overseas entities. U.S. shareholders of these overseas entities will have to include their share of the entities’ GILTI inclusion in their taxable income (where it will be subject to US taxes). This inclusion is required irrespective of whether that income is repatriated to the U.S.
The GILTI legislation also adopts a concept of measuring income against a 10 percent return on depreciable tangible assets and deems any non-Subpart F/non-ECI return in excess of this 10 percent benchmark to be GILTI. This GILTI is then generally taxed at a U.S. rate of effectively 10.5 percent (until 2026), and incremental U.S. tax on such income may be reduced by foreign taxes already paid in respect of such income.
The combined message of the FDII and the GILTI is that U.S. companies that derive foreign income from certain intangibles will get tax breaks. However, the U.S. tax regime will apply a global minimum tax on overseas income derived by non-U.S. subsidiaries, especially as it relates to income generated in business that are not tangible-capital intensive business. Ironically, a lesson from the FDII and GILTI regimes is that it may be advantageous in the post U.S. tax reform environment to shift certain capital intensive activities (e.g., plants and large manufacturing facilities) outside the U.S. while bringing certain IP and service activities into the US.
Companies should be asking themselves: Are any of the FDII carrots big enough to warrant moving IP to U.S. and rethinking some of their investment strategies? Businesses that embrace the changes early and accurately model the effect put themselves in an excellent position to capitalize on the opportunities US reform may offer to support their business growth ambitions.
However, I don’t expect to see to many companies making proactive changes to their business strategies in the shorter term. The rules are too new and there are a number of unintended consequences in the hastily written statute that need to be ironed out to give clarity. Longer term, there may be ways to simplify or change the supply chain and operating model, but such changes may be disruptive in the short term and so need to be approached with care.
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