Don t miss the BEAT on US tax reform. Seize the opportunity to improve and digitalize your operating model

Transcription

1 Don t miss the BEAT on US tax reform Seize the opportunity to improve and digitalize your operating model

2 Overview The US Tax Cuts and Jobs Act was passed at the end of It is the most significant change to US corporate and international tax in a generation. US tax reform will have a significant impact on business: from how corporate assets are financed to how businesses are structured. Companies need to take a holistic approach that takes into account both business and tax issues in order to position themselves in a leading position. As with any change of this magnitude, there are potential negative impacts in addition to new opportunities to seize the upside of disruption. We have identified eight impact areas as companies look to adopt an efficient operating model, which are explored in greater detail in this document. This document is not an exhaustive tax technical document but is designed to highlight eight key operational elements of US tax reform, especially tailored to the needs of senior business and operational employees, executives and boards of directors. Highlights of the final legislation Below is an overview of some of the key corporate and international tax provisions that may be relevant. More information can be found on page 10. Lower corporate tax rate Corporate tax rate is reduced from 35% to 21%, effective 1 January 2018, for calendar and fiscal year-end taxpayers. Broader tax base To compensate for lower tax rates, the bill modifies and, in some cases, eliminates, certain deductions and credits, including a tightening of the US interest deduction limitation rules (i.e., EBIT(DA) interest limitation rule). In addition, it contains provisions that broadens the tax base with the creation of an anti-base erosion provision (BEAT), which is an additional tax that effectively limits the deductibility of certain related party payments. Examples include paying HQ or services fees, royalties, franchise fees, or paying for procurement services to overseas companies. New international tax system The limited participation exemption regime included in the bill is offset by a one-time transition tax on unrepatriated earnings. Note that US tax reform includes a new category of global intangible low-taxed income (GILTI), which effectively imposes a global minimum tax on US-owned group companies outside the US. This results in non-us earnings becoming subject to a maximum US tax rate of 10.5% (increasing to % after 2025). Incentives The bill includes incentives intended to motivate companies to base certain activities and assets in the US. These include 100% expensing of tangible assets and a new preferential 13.5% tax rate on export income FDII, e.g., export sales, services, leases or licenses of property to non-us entities or persons. 1 Don t miss the BEAT on US tax reform

3 Far-reaching impact of US tax reform The US Tax Cuts and Jobs Act was passed at the end of 2017 and represents the most significant US tax reform in more than 30 years. Most of its provisions came into force on 1 January For many groups headquartered in Europe, the Middle East, India and Africa (EMEIA), the US represents their largest foreign operations. Conversely, US companies traditionally have significant investments in the EMEIA market. US tax reform has widespread business implications. MNCs should review financial and operating aspects, looking at how their business operates, invests, competes and delivers products and services. Whether headquartered in EMEIA, the US or elsewhere, it is imperative that MNCs review their corporate strategy and take action as necessary. At a time of increasing transparency overshadowing global operations for example, the Organization for Economic Cooperation and Development (OECD) Base Erosion and Profit Sharing (BEPS) initiative and the EU s Anti-Tax Avoidance Directive (ATAD), this reform acts as a further layer of scrutiny. Companies with historic structures based on traditional tax planning strategies should urgently review their tax models and risk profile. Other MNCs should reassess their current operating model to identify any operational and fiscal opportunities and mitigate potential risk impact. US tax reform as a driver for change In a rapidly changing landscape, businesses are being disrupted by new digital technologies and business models. New regulatory and tax requirements are being adopted at a pace never seen before. Operating models are changing as a result of an unprecedented degree of globalization and protectionism. US tax reform is yet another critical change that radically impacts the way business is conducted. In summary, US tax reform will have a significant impact on MNCs : Strategy, design principles and business case Governance and performance management Operating structures Liquidity, investments and capital People, processes and organization This challenging new legislative environment comes at a time when digital disruption and a sharper definition of global scale and local competitiveness is already challenging the status quo. Leading companies will seize this opportunity to take a holistic approach and transform their supply chains to improve business performance, and develop agile operating models to help them compete in today s digital world. MNCs should take into account everything from talent and labor required, to IT systems implications and the legal and regulatory environment. The specific priorities will vary depending on the nature of the products being sold or services delivered. Supply chain network Transactional model Business processes Transfer pricing Systems information and data Corporate business services People organization and location Corporate tax and legal entity structure Don t miss the BEAT on US tax reform 2

4 US tax reform Eight impact areas that will shape tomorrow s operating models US tax reform is broadly welcomed as positive news; however, there are a number of elements that could negatively impact MNCs operating and tax models. For example, the corporate tax rate reduction from 35% to 21% is a positive element for most companies. In many cases, MNCs with material US operations will see a reduction in their overall tax burden, which will create opportunities and obligations to utilize capital more competitively. Combined with other measures, it might even encourage movement of activity to the US. However, as previously mentioned, there are certain provisions that could have adverse implications. It is critical for today s MNCs to fully identify, quantify and mitigate the associated risks. MNCs need to reconsider their risk appetite for certain structures and arrangements. Supply chain flows and payment options on royalties, interest, rents and services need to be reviewed and may need to be transformed. More drastically, the new provisions may require that MNCs change, or even unwind, existing hubs, principals, intellectual property (IP), holding and financing structures. 3 We have identified eight key areas of impact that MNCs should consider as they take a holistic perspective on their future operating models. US tax reform: 1 Acts as an accelerator to run business units or entire companies more globally and pushes alignment on digital strategies 2 Continues the business for US MNCs center led structures with the appropriate business functionality outside the US 3 Promotes certain investments in the US, especially with US export models 4 Demands reassessment of the alignment of IP ownership and R&D activity with the new operational and tax requirements 5 Reveals the people aspect as a hidden driver for change 6 Highlights the need for companies to review their treasury plans and assess their capital and leverage profiles 7 Creates an urgent need for both US and non-us MNCs with fee-based structures to reassess their US setup 8 Changes the M&A strategy, which could boost results and IPO activity Don t miss the BEAT on US tax reform

5 1 Acts as an accelerator to run business units or entire companies more globally and pushes alignment on digital strategies Prior to US tax reform, MNCs typically structured their US setup in a different manner from their non-us operations. The complicated US tax and regulatory environment resulted in business models that were specifically tailored to the US market. Meanwhile, new (digital) business models are rapidly developing as a consequence of artificial intelligence (AI), Internet of things (IoT), adaptive manufacturing and autonomous supply chains. Put simply, MNCs are redefining the way they operate. With increasingly blurred lines between sectors, the emergence of innovative pricing models and diversification of revenue streams, there is a need for more efficient and intelligent operations. The new tax code could be an accelerator to run business units even entire companies more globally. US tax reform may influence the preferred location for future investments. The US could be considered as a hub for new activities and investments and, in conjunction with modern technology, there might not always be a need to run US operations in silos. Processes can be more closely aligned to business policies and objectives. The FDII export incentive could, for instance, be a trigger to start with adaptive manufacturing in the US and export to non-us jurisdictions. Therefore, it is more important than ever to align the digital strategy of your organization with your operating and tax model. 2 Continues the business for US MNCs center led structures with the appropriate business functionality outside the US One of the most important equations to solve for US MNCs with center-led structures is how to structure foreign investments in a post-us tax reform world. Companies should ask themselves: does it still make sense from a business economic perspective to have a non-us principal structure? Do operating benefits outweigh the incremental cost of doing business in certain jurisdictions and how will US tax reform impact this calculation? These are three important questions that are easy to ask but difficult to answer. However, two things are clear: US MNCs with center-led structures in EMEIA or Asia-Pacific (APAC) are still viable in a post-us tax reform landscape. The typical effective tax rate achieved remains attractive when compared with the US combined federal income tax and state tax rates, provided, of course, that the combined operating and tax benefit of having a centralized structure outside the US outweighs the incremental cost of doing business in the principal jurisdiction (e.g., proximity to suppliers or customers, localized markets and regulatory requirements). For some organizations where business functionality is considered insufficient, it may be necessary for their EMEIA and APAC operational activities to be increased or alternatively, these overseas operations may require to be more aligned with activities performed in the US. This is particularly relevant given increasing global challenge of MNC s operational business and tax models. In summary, companies must still have a gateway to their non-us customers, thereby making it imperative to test alternative structures and models. 3 Promotes certain investments in the US, especially with US export models US tax reform has the goal of enhancing US competitiveness in the global economy. The lower statutory tax rate, the introduction of export incentives (FDII) and the possibility to immediately write off certain tangible depreciable assets are three key components to making the US economy more competitive. The combination of these elements could be interesting for any short and medium-term business investment. Local incentives such as tax credits and job training possibilities enhance the attractiveness for corporations to move assets and activities to the US. The US could also be seen as an investment hub for investments in the broader Americas. The enacted reform can act as an incentive to help steer technology investments, while also incorporating the digital advances of the recent years in the setup of their US operations. This is expected to be especially relevant for an MNC s future manufacturing footprint and, consequently, for its supply chain and logistics warehousing setup. However, when performing an assessment, companies need to take a holistic view where to deploy their tangible and intangible asset base, taking into account all other operational and business requirements and objectives. Careful evaluation of trade-offs to set the right direction is essential. Don t miss the BEAT on US tax reform 4

6 4 Demands reassessment of the alignment of IP and R&D activity with the new tax and operational requirements A number of US tax reform elements are in line with international tax trends and developments, which specifically address structures based on traditional tax planning techniques whereby the R&D activities are not always aligned with legal and economic intellectual property (IP) ownership. In a world with increased transparency, exchange of information and attention to business operational alignment, it is important to ensure that a MNC s tax model is properly aligned with its R&D activities and development of tangible and intangible assets. MNCs need to reassess whether their IP ownership is already appropriately aligned with their operating model. If this alignment is not present, MNCs should urgently reassess their global R&D processes and, as a consequence, important questions such as the following need to be answered: what are the benefits and risks of bringing IP (back) to the US versus onshoring or offshoring it, with appropriate business functionality, to overseas territory, provided it satisfies MNCs operational and tax requirements? How do you ensure the IP tax strategy is aligned with the operating model? There are several considerations that affect cost and benefit calculations, including the tangible depreciable assets, the current ETR of the group, the current location of the IP, and the degree of alignment between the IP location and the supply chain. Whatever the eventual response will be, it will require new capital investments, strategy and financing plans. 5 Reveals the people aspect as a hidden driver for change US tax reform alters the personal taxes of individuals, the executive compensation plan and the employer-provided benefits for individuals exposed to US taxes. Moreover, the deployment of employees is of significant importance when companies consider changing their operating model or changing their deployment of assets, risks and functions. A response to US tax reform should include a review of the current compensation programs for corporate executives, the design of benefit programs, workforce strategy, sourcing, retention and location, and immigration risk and compliance. Operating models need to be carefully documented, especially as taxable profits attach to the management and control of functions, assets and risks. Eventually, an MNC should find the right balance between i) having a stable foundation to mitigate key risks and ii) having the appropriate functionality in a jurisdiction to deliver operational results. 6 Highlights the need for companies to review their treasury plans and assess their capital and leverage profiles Foreign profits of US MNCs trapped abroad will be subject to a one-time transition tax at a reduced rate. This could allow for the movement of cash within a global corporate structure to be deployed with more flexibility inside or outside the US, depending on MNCs requirements and ROI expectations. In addition, given the new interest deduction limitation rules in conjunction with the traditional highly leveraged US operations (typical current setup due to pre-tax reform high statutory tax rates), companies need to re-evaluate how to finance their assets and operations in the US. This is especially relevant as scenarios exist where interest payments are non-deductible and, at the same time, the same interest payments are subject to extra US taxation due to the BEAT provisions. Questions such as how to cut debt on US operations balance sheets and how to reduce borrowings will arise. The response should be reflected in a revised treasury plan that i) mitigates the risk of interest being non-deductible ii) takes into account the changes in the carryback of net operating losses rules and iii) is aligned with the financial reporting forecasting and modeling that contains the relevant considerations for tax-efficient movements of cash within corporate structures. 5 Don t miss the BEAT on US tax reform

7 7 Creates an urgent need for both US and non US MNCs with fee-based structures to reassess their US setup Companies that use non-transactional models, procurement models with agency or procurement support fees, service company structures, and other similar payment models targeted by the US tax reform, need to assess the sustainability of these structures. The BEAT provisions could negatively impact these models and typically lead to additional or double taxation. MNCs should protect their current setup, enhance their operations or, in the case of significant impact, transform their (US) operating model. Any position taken, for instance when certain payments are part of the cost of goods sold (COGS) and therefore not considered to be in scope of the BEAT provisions, should be carefully documented given that additional legislative guidance is expected. This is relevant as it could change current diverse views on certain elements and could mitigate future controversy risks. Transfer pricing and international law considerations should be carefully taken into account, especially as there may be a mismatch between US and non-us interpretation, which amplifies the need for a more granular transfer pricing analysis based on the functional profile and detailed description of processes, functions and roles. MNCs need to consider the potential of having buy-sell transactional models, more local trading and sourcing activities, and a revised transactional and transfer pricing setup. Above all, it is important that any change in a company s operating model will help to sustain or improve KPIs including supplier collaboration and communication, lead times and supply chain costs. 8 Changes the M&A strategy, which could boost results and IPO activity The drop in the statutory tax rate, immediate expensing rules, GILTI, and new rules on tax deductible interest, will change MNCs M&A strategies (e.g., asset based instead of share-based purchases). It amends investment and acquisition decisions in addition to impacting the way transactions are financed. With no grandfathering rules for the interest deduction limitation rules, US tax reform will not only impact future M&A transactions but also limit the use of debt financing in existing setups. MNCs need to reassess how to price and structure investments and acquisitions, taking into account a number of factors, e.g., a company s financial position, risk preference, company and industry attributes. Valuations need to be updated and IPOs could become more attractive, especially as the effective cost of debt increases and the change in the statutory tax rate impacts discount rates. In view of the GILTI, MNCs may want to focus on non-us fixed asset-heavy companies as acquisition targets, and asset deals, in general, may become more interesting. All in all, as US tax reform pushes MNCs to polish up their M&A strategy, it will fuel investment and acquisition decisions and, whether as buyer or target, MNCs need to prepare for potential waves of M&A activity. Don t miss the BEAT on US tax reform 6

8 Navigating the impact of change Managing and planning for the impact of the new legislation involves understanding the new provisions and their effects, and aligning across all functional areas of an enterprise to implement strategies that account for these changes. We have identified three key steps MNCs should take to help navigate this change: Inform Articulate and size the key impacted areas Consult with relevant stakeholders to align with business competitive requirements Determine approach for an impact assessment Assess Impact assessment based on specific facts and circumstances Test feasibility of alternative models in close cooperation with business leaders who are likely to be reviewing their business operations in light of today s digital disruption Transform Design and implementation program reflecting the impact of US tax reform and other current global and local initiatives and legislative requirements Following this approach, organizations can kick-start the process of building a customized operating model that is aligned to their key capabilities today and the key capabilities needed to compete tomorrow, while being aligned with the new legislative landscape. Key conclusions and observations US tax reform can generate value In a rapidly changing environment, organizational agility combined with having the appropriate business functionality is more crucial than ever in order to justify profit allocation and mitigate the impact of US tax reform. A robust response to US tax reforms is important, not only to move fast but also to create a stable foundation, which can help reduce controversy risk. US tax reform could be the catalyst to introduce cutting-edge technology to a company s operating model, and could fuel technology investments. Value potential could be unlocked by digitalizing an MNC s operating model, leveraging available (tax) incentives, freeing up cash, and updating strategy and investment plans. Eventually, this could act as a driver or accelerator for improved productivity, margins and returns. Above all, it will require an aligned operating model, tax structure and (digital) strategy. It is imperative to perform a detailed assessment of whether the current setup is optimal, taking into account change management, transition costs and any potential disruption to the business. In order to enhance value creation, MNCs should thoroughly evaluate all investment decisions and reassess their risk appetite. This is especially relevant for MNCs with traditional tax planning structures, heavy procurement and other service fee-based models, in addition to MNCs with a mismatch between R&D activities and IP ownership. Sustainability of the tax reform As a general rule, US tax reform will accelerate the focus on the alignment of business and tax strategies, whereby tax leakage is carefully managed. A deep understanding of the tax technical provisions and their interactions with other international tax and regulatory developments such as BEPS, ATAD and unilateral legislative actions (e.g., taxes on the digital economy) is required. Conversely, MNCs need to assess the sustainability of the tax reform and consider carefully when undertaking scenario planning. Future political terrain could be uneven given 2018 US mid-term elections, the apparent contradictions to certain international agreements such as those of the WTO, and a potential response from the EU. Therefore, it is key that MNCs build flexibility into their value chains so that if a new administration increases tax rates or, more dramatically, repeals a part of the enacted tax code, the change will not negatively impact its competitiveness. Tax as a contributor to boardroom discussion Having the capabilities to quickly understand and manage change is key for sustainable success in the face of increased volatility. It is therefore important that tax is integrated in the company s strategy definition. MNCs should take a holistic operating model design approach ensuring a strategy that is reflected in transactional models with appropriate business functionality and follows operational and business requirements. US tax reform acts as a key driver for aligning a company s tax model with its operating business and corporate (digital) strategy. So, the big question is, what action are you taking? 7 Don t miss the BEAT on US tax reform

9 Why EY? We have a proven and standard approach refined over more than 20 years in carrying out successful operating model design projects. We have conducted more than 175 operating model transformation feasibility and design projects; in addition to supported with more than 80 implementations a track record which significantly outperforms our competitors. We have global mobile teams that match the footprint of your business, with hubs and dedicated professionals in North America, Latin America, Europe, the Middle East, Hong Kong and Singapore. Through the breadth and depth of our Advisory, Transaction Advisory Services and Tax services, we are organized to assist companies with improving their operating model across the different tax and business layers: business restructuring, processes, organization, systems implications, transfer pricing, direct and indirect tax, customs, human resources, finance and accounting. People relocation Valuations Sales and marketing SOX compliance Supply chain transformation Business process design Program and change management Management reporting Location advice Tax Reduce tax risk and improve benefits Finance transformation Treasury Regulatory issues Organization design Legal Accounting and reporting Business Improve business engagement and enhance compliance Corporate reputation People and change Tax and legal restructuring IT advisory Transfer pricing Operational tax advice Customs/international trade advice Indirect tax/vat advice Legal structuring tax advice Don t miss the BEAT on US tax reform 8

10 Key contacts Joost Vreeswijk Nathan Richards EY EMEIA Operating Model Effectiveness Leader, Ernst & Young AG, Switzerland Operating Model Effectiveness, Switzerland T: E: T: E: Joe Kledis Edvard Rinck EY EMEIA US Tax Desk Leader, Ernst & Young LLP, United Kingdom EY APAC Operating Model Effectiveness Leader, Ernst & Young Solutions LLP, Singapore T: E: T: E: Marc Schlaeger Yvonne Metcalfe Operating Model Effectiveness, Denmark Operating Model Effectiveness, United States T: E: T: E: Operating model effectiveness contacts 9 Jay Camillo Mohi Khan United States United Kingdom T: E: jay.camillo@ey.com T: E: mohi.khan@uk.ey.com Joris W van Roijen Jürgen Lange United States Germany Tel: E: joris.vanroijen@ey.com T: E: juergen.lange@de.ey.com Danny Loa Julian Tasker The Netherlands United Kingdom T: E: danny.loa@nl.ey.com T: E: jtasker@uk.ey.com Jillian Symes Jeroen Truin United Kingdom Switzerland T: E: jsymes@uk.ey.com T: E: jeroen.truin@.ch.ey.com Don t miss the BEAT on US tax reform

11 Appendix The below is an overview of some of the key corporate and international tax provisions included in the US tax reform bill that may be relevant to both US and non-us MNCs. Relevant provisions 1. Anti-base erosion measures (BEAT) An additional tax that effectively disallows certain related party deductible payments Imposed on US corporation that has average annual gross receipts of at least US$500m for three-year period and a base erosion percentage of 3% or higher 5% rate for first year and 10% thereafter (rising to 12.5% from 2025) Includes royalties, interest and certain service payments but excludes COGS 2. Foreign-derived intangible income (FDII) Export incentive that provides a reduced effective US tax rate on certain export income A % effective rate of US tax (increasing to % after 2025) on export sales, leases or licenses of property to non-us persons for use outside the US, and services provided to non-us persons 3. Global intangible low-taxed income (GILTI) Effectively imposes a global minimum tax on US owned group companies outside the US Generally subjects to current US tax the aggregate profits of all CFCs in excess of a 10% routine return on tangible depreciable assets Effectively subjects the non-us earnings to a maximum US tax rate of 10.5% (increasing to % after 2025) 80% foreign tax credits (FTCs) available 4. Interest expense restrictions Net interest deductions limited to 30% of EBITDA (further restricted to EBIT beginning in 2022) Applies to related and unrelated party debt 5. Limited participation exemption 100% dividends received deduction on qualifying dividends paid by foreign corporations to 10% US corporate shareholders 6. Rate reduction 21% corporate tax rate beginning 1 January 2018 for calendar and fiscal year-end companies 7. Temporary 100% expensing Immediate write-off of tangible depreciable property placed into service after 27 September 2017 and before 2023; taxpayer may elect to apply 50% expensing for the first tax year after 27 September Transition tax 15.5% for earnings held in liquid assets, 8% for illiquid assets One-time transition tax on accumulated foreign earnings payable upon US shareholder election over 8 years in increasing installments (8% for first five years; 15% in year six; 20% in year seven; and 25% in year eight) Measurement date is the greater of amount determined on 2 November 2017 or 31 December 2017 Don t miss the BEAT on US tax reform 10

12 EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com EYGM Limited. All Rights Reserved. EYG No GBL EY indd (UK) 04/18. Artwork by Creative Services Group London. ED None In line with EY s commitment to minimize its impact on the environment, this document has been printed on paper with a high recycled content. This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax or other professional advice. Please refer to your advisors for specific advice. ey.com