Given his public persona, it is not a surprise that President Trump decided against meekly tinkering with the U.S. tax system. Instead, The Tax Cuts and Jobs Act (“TCJA”) fundamentally reformed and complicated parts of U.S. taxation, especially those areas that govern how the U.S. taxes transactions with the rest of the world.
While tax advisors have been wrapping their heads in cold towels to work out what exactly the reforms mean, tax policy-makers seem to have been wrong-footed. Some of the proposals mark a shift from the international consensus about how to tax cross-border activities.
Tax Policy has been Left Behind
Most tax systems, both globally and in domestic jurisdictions, are antiquated. Modern business practices simply do not fit the assumptions made by the drafters of historic tax codes, many of which were put together decades ago. Global businesses and digital supply chains simply didn't exist when most mature economies developed their tax approach. The draft OECD model double tax convention was first published in 1963—having consolidated four other approaches, the earliest dating from 1958.
It then only took until 1977 for the draft to be finalized. Things move slowly when it comes to international co-operation and consensus, particularly in the world of tax, where changes create winners, and losers, from a revenue perspective. Just ask the OECD, which continues to press for international agreement on measures to counter base erosion and profit shifting (“BEPS”). While the convention has been updated, it still has those original 1977 foundations, which remain of their time. Given the speed of tax policy compared to the speed of business innovation, it's not surprising that tax policy has been left behind.
Attempts to Build Agreement
Over the last few years, multilateral organizations such as the OECD have done steady work in trying to build agreement as to how to tax international transactions. The BEPS project has tried to develop common themes, such as updating what it means to have a “permanent establishment”, proposing limits on interest deductions and so on. Other pet projects exist; the European Union (“EU”) has proposed (and continues to propose) its Common Consolidated Corporate Tax Base (“CCCTB”) (44 TPIR 4, 2/28/17) to little effect, although, ironically, Brexit may make it easier for the EU to deliver on this.
Individual countries have tried their own approaches, although this is within broadly agreed frameworks: the U.K.’s limitations to interest deductions and the diverted profits tax, Italy's digital sales levy and the Dutch dividend withholding regime reforms are recent examples. None of these have proved to be especially controversial, as they generally build on what has gone before.
TCJA's New Approach Causing Concern
The TCJA has ignored the incrementalist approach. Significant tax cuts have been introduced, making U.S. corporate taxes much closer to the OECD average of 23.75 percent. This flies in the face of the salami-slicing approach that has characterized, for example, the U.K.’s corporate tax rate reductions. There are merits to both approaches: businesses value certainty above all because it allows leaders to plan effectively—a low rate has its attractions, but certainty and stability probably still trump unheralded tax cuts.
Among other measures, cash can now be repatriated more cheaply through dividends, foreign derived intangible income is taxed at a favorable rate and payments to foreign affiliates could be subject to a base erosion minimum tax.
This makes uncomfortable reading for non-U.S. tax authorities. Businesses from the world's largest economy have less use for lower tax jurisdictions, or at least the benefits of being in those jurisdictions are significantly reduced. U.S. tax credits from higher tax jurisdictions now can't be fully utilized against the lower U.S. taxes. A restructuring of operations could be a possibility.
It's not surprising that the reforms haven't had a positive reception outside the U.S. The finance ministers of Germany, France, the U.K., Spain and Italy wrote to the U.S. before the bill was passed, expressing concern that the proposals were unfair. They suggested that the U.S. may be looking to seek a trade advantage under the guise of attacking tax abuse. As ever, tax abuse is in the eye of the beholder. Most individuals and companies believe they pay their “fair share” of tax: it is always other people who don't pay.
Questions have also been raised as to whether the legislation is compatible with the World Trade Organization (“WTO”) provisions, as providing preferential treatment for U.S. corporates could represent an unfair export subsidy. Equally, the provisions that subject cross-border transfers within banks and finance companies to a 10 percent tax are being argued as putting international lenders at a disadvantage.
There is a history of friction between the EU and the U.S. on tax matters. These disagreements are often dressed up in the form of trade disputes. For example, actions taken by the European Commission against Amazon and Apple to clamp down on so-called tax sweetheart deals could be argued to be aimed at driving up tax rates for large businesses under the cover of the competition law.
Tax policy is a difficult job. Everyone—from politicians and tax authorities through to businesses and electorates—wants to ensure that enough tax is paid to support public services. Current tax law doesn't do this and this is not just because some businesses look to exploit it. As mentioned earlier, it remains the case that a lot of law is not fit for the modern business environment.
Getting agreement among countries is slow and it always has been. Changes tend to be incremental. Unilateral, non-incremental change has its own challenges. The winners are pleased, the losers are not. It's difficult to challenge another country's right to make its own tax law, so disputes spill into different arenas such as the WTO. While this may be inevitable, it means that the world is stuck with its outdated tax systems and electorates get frustrated that tax isn't collected. Breaking this impasse will not be easy, no matter President Trump's forthright opinions on the matter.
By Laurence Field, Corporate Business Tax Partner at national audit, tax and advisory firm Crowe Clark Whitehill. Crowe Clark Whitehill are the U.K. member firm of Crowe Horwath International, the eighth largest global professional services network, with more than 200 member firms operating across the globe.
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