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Sébastien Maury and Luan Nussbaum KPMG Switzerland
Sébastien Maury is Director and Luan Nussbaum is Senior Manager at KPMG Switzerland
On December 22, 2017, President Trump signed the tax reform bill commonly referred to as the “Tax Cuts and Jobs Act” that was passed in Congress two days earlier. This reform represents the most significant and fundamental tax reform in the U.S. since 1986. How will the new tax law affect Swiss groups?
The new law includes significant changes in domestic tax law. It also includes significant changes of international tax provisions. Said that, not only U.S. multinationals, but also foreign multinationals with U.S. operations are affected by the reform. The present article provides a short overview the new tax law as well as preliminary thoughts and inputs in terms of how it may affect Swiss groups.
The new tax law implements a reduction of the Federal tax rate from 35 percent to 21 percent. In addition, it foresees an accelerated (even immediate under certain circumstances) expensing for capital investments in certain new and used depreciable assets acquired and placed in service after September 27, 2017 and before January 1, 2023.
At the same time, various tax base enlargement measures are introduced. These include interest deduction limitation that is much more severe than the tax law in force until end of 2017. Indeed, the new limitation applies to all interest (not only disqualified interest). In addition, deduction is denied for interest (and royalties) that are paid or accrued to a related party in connection with a hybrid transaction and/or hybrid entity. Measures also include the limitation of Net Operating Losses (“NOLs”). In this regard, the new tax law limits the annual use of NOLs carryforward to 80 percent of the loss of the corporation's taxable income. Finally, the new tax law also provide for the elimination of certain deductions (such as those for domestic production activities or deductions for employee benefits).
Swiss groups, in particular those in capital intensive businesses, might on the one hand benefit from both the reduction in the statutory rate and the accelerated expensing for investments in U.S. assets that could foster new investments in the U.S. On the other hand, they may be negatively impacted by the limitation of interest deduction or the limitation of NOLs. They should therefore review their current U.S. financing structures and U.S. NOLs situation.
The new tax law foresees a move from the current system of worldwide taxation to a territorial regime with a 100 percent participation exemption on foreign dividend income (but not on capital gains). Due to such fundamental change, U.S. shareholders with an interest in a foreign corporation have to take into consideration the undistributed, non-previously taxed foreign earnings that would be subject to a mandatory repatriation and as a result taxed immediately at a rate of 8–15.5 percent, depending on the type of assets. The current Controlled Foreign Corporation (“CFC”) and Subpart F (provisions that require immediate inclusion of certain types of foreign income in the U.S. tax base) rules will be maintained with some amendments.
An important provision in the new law is the introduction of “Global intangible low taxed income” (“GILTI”). Although lowering the U.S. statutory rate from 35 percent to 21 percent, this provision reflects a concern that shifting to a territorial tax system could exacerbate the U.S. base. It basically results in a 10.5 percent minimum taxation on foreign profits. This would lead to a new sort of global minimum tax on U.S. corporate shareholder's pro-rata share of certain foreign subsidiary earnings. In essence, the tax would amount to 10 percent of foreign subsidiaries' non-subpart F/non-effectively connected income (“ECI”) in excess of a deemed routine return amount on tangible depreciable property. Foreign tax could be credited up to 80 percent.
Swiss groups with U.S. subsidiaries that own foreign subsidiaries (“sandwich structure”) might be affected by these changes. In particular, they may be subject to mandatory repatriation for non-distributed earnings sitting underneath a U.S. subsidiary. They may also be caught by the above mentioned changes in CFC rules. In addition, the residual withholding tax rate of five percent under the Swiss–U.S. double tax treaty might become a final tax charge (since no U.S. foreign tax credit would be possible).
A Base Erosion Anti-Abuse Tax (“BEAT”) would be levied on “bad” payments to foreign affiliates of U.S. companies. Bad payments under BEAT do include interest, royalties or service payments to foreign related parties but do not include costs of goods sold. It operates as a minimum tax: it is levied at a rate of 10 percent on the portion of the U.S. corporation's modified taxable income which exceeds the tax computed under the regular rules.
The BEAT applies to U.S. corporations part of large taxpayers group but relatedness based on significantly lower common ownership threshold (only 25 percent). By large taxpayers group subject to the rule, sole the groups with annual average global U.S. gross receipts higher than $500 million over three years and with a base erosion ratio (determined by the base erosion deductions divided by the total allocable deductions) higher than three percent. A minimum 10 percent tax imposed for those companies having certain deductible “base erosion payments” made to related foreign companies (special 11 percent rate applies for affiliated groups that include banks and/or securities dealers).
Switzerland is an exporting economy and the U.S.one of the largest markets worldwide. Swiss companies are the 7th largest foreign direct investors in the U.S. with investments of approx. $320 billion (according to U.S. Dept. of Commerce, Bureau of Economic Analysis). It is obvious that the rules briefly described above might affect Swiss groups significantly. Industries relying on a Swissmade label or on “Swissness” such as the watchmaking, banking, pharmaceutical or (re)insurance industries might be the most affected. Swiss groups should therefore thoroughly assess the impact of the new rules and consider measures to adapt their value chain. The review should also consider other international tax developments driven by BEPS, the EU or Switzerland.
From a financial reporting perspective, the changes depicted above do impact the deferred tax positions under IFRS and U.S. GAAP accounting standards. Since they have been enacted in 2017, they have to be accounted for in the financial statement for 2017 already.
The Act proposes fundamental changes to some core elements of the U.S. Tax Code impacting individuals. Those that will most directly affect the Global Mobility programs of Swiss Group companies include:
Although, here, we have consistently referred to the repeal of 2017 law for ease, actually most of the new laws pertaining to individuals are set to expire, or “sunset”, at the end of 2025; at that time the law would revert to that which was in place at the end of 2017. It, therefore, remains to be seen whether the popularity of some of the measures makes them politically indispensable once their time is up.
While focusing on the corporate tax implications of the reform, Swiss and foreign groups should not forget to assess the implications on their U.S. expatriates.
The new tax law also affect Swiss groups by re-defining all relevant tax attributes in the U.S., including the tax rate, tax base and treatment of intercompany transactions. Swiss groups should keep their head on and in a first step thoroughly assess the impact action-by-action with the help of the appropriate modeling tools.
As a second step, they should look in the “quick fix” measures that could be taken to mitigate the impact and uncertainty in the short-term.
Finally, they should explore the measures which mitigate the impact and uncertainty in the mid- and long-run. These may include for example restructurings of their supply chain. Groups should always keep in mind that a holistic view should be taken into account when carrying out this kind of analysis and that other international tax and regulatory developments have to be factored into their analysis.
Sébastien Maury is Director and Luan Nussbaum is Senior Manager at KPMG Switzerland.
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