As Donald Trump’s inauguration day (January 20) approaches, many UK businesses which have invested in the US are awaiting further details on his tax plans, particularly those affecting multi-national businesses. In my blog on 15 November, I discussed how his proposals might affect the cash piles of US based multi-nationals; but what do they mean for UK based groups with large US subsidiaries?
Of course, any tax changes are only one element in an economic policy that looks like it will be very different to what has gone before, and businesses will be making investment decisions based on what they expect the wider implications of that policy to be; however, those wider implications, whatever they are, are beyond the scope of this blog, which will stick to the tax proposals.
The first thing to say on possible tax changes is that little additional of substance has emerged since the Trump victory; the 'Trump Proposals' as we know them, remain a reduction in US corporate tax rates, a one-off charge on existing 'offshore cash piles' and ongoing taxation of offshore tax going forward; and some broadening of the tax base, including, potentially, restrictions on the deduction of interest for tax purposes by large businesses. However, the President-elect has had things to say on matters such as promoting exports and US jobs and discouraging imports and, combining these with other tax thoughts coming out of Republicans already in the US congress, such as Paul Ryan may point to even wider measures.
Sticking with the Trump proposals made before the election, the prospect of Federal corporate taxes being cut from 35 per cent to 15 per cent looks like good news for UK investors into the US; a lower tax rate should give higher returns. However, the effective rate of Federal tax is already below 35 per cent for most investors due to various tax deductions and exemptions, and these seem likely to go if the Federal rate is substantially reduced. More significantly, investors into the US can reduce the effective tax rate on US profits by substantially financing those subsidiaries by inter-company debt. If this is effectively prevented by the Trump reforms, the increase in returns may not be as high as it might initially look. Finally, it is worth mentioning that Federal tax is not the only tax on corporate profits; state and local taxes also take a slice, and these are charged before the Federal tax, at rates of typically five to eight per cent. There is no guarantee States will follow the Federal lead. With no change in state rates, the overall effective rate will come down to 19 - 21 per cent; with other 'base-broadening' measures, the true comparison might be around 20 per cent on virtually all US profits compared to 39 per cent on somewhat less than all US profits.
Moreover, if financing the US by debt is no longer sensible, this will impact on how to finance future US investments; with the UK introducing limits on net interest deduction, borrowing in the UK to finance US investment may become less attractive if the interest expense cannot be passed down to the US.
It could get even more interesting however. The President-elect has talked about 'border taxes' on companies that move production outside of the US, and Senator Paul Ryan and the House Republicans have suggested reforming corporate income tax to turn it into a cash-flow destination based tax – 'taxing imports but not exports'. These proposals would have a profound effect on companies doing business in the US. In a globalised world, many products are made from components made in several countries; services can be sourced from abroad (and they represent a key UK 'export'); and many multi-national groups concentrate some activities – from 'routine' back-office invoice processing to R&D – in a small number of centres. What would a 'destination based cash-flow' tax mean for the taxation of a US subsidiary of a UK multi-national selling product in the US which needed components from outside the US, which was based on non-US R&D and for which sales invoices were issued from (say) India? Some commentators have speculated tax rates could exceed 100 per cent on some US profits!
Post -inauguration on Friday (20), I will be looking to see if the new administration moves in the “conventional” direction of a significant rate cut with a broadening of the tax, which is something relatively easy to model and explain to UK management and investors; or a “radical” change, taking the US towards a tax system unfamiliar to most of us, which could have dramatic, and currently very difficult to predict, implications for UK businesses operating in the US.
Blog by Glyn Fullelove, Chairman of the Technical Committee of the Chartered Institute of Taxation.More Articles by Chartered Institute of Taxation (CIOT) ...