Business Tax Reform: Where Are We Now?

Transcription

1 70 th Annual University of Chicago Law School Federal Tax Conference Nov. 3, 2017 Business Tax Reform: Where Are We Now? Rosanne Altshuler David Hariton David P. Lewis Nicholas J. DeNovio (Moderator) 0

2 Agenda Key Business Taxation Elements of Tax Cuts and Jobs Act (the Act ) released by House Ways and Means Committee on Nov. 2: Corporate Rate 20% Tax Rate on Certain Business Income of Individuals 25% Immediate Write Off for CapEx for next 5 years Partial Limit on net business interest deductibility Territorial System for Future Earnings 100% Exemption, with Minimum Tax of 10% on Certain Foreign Earnings and Preservation of Significant Part of Subpart F Rules One-Time Tax on Overseas Earnings 12% (cash and cash equivalents) and 5% (other assets) New Section 4491 Excise Tax on Amounts from Domestic Corporation to Foreign Affiliate Special Issues: Base Erosion Concerns: Reconciling Minimum Tax on Global Earnings with level the playing field between U.S. and non-u.s. HQ companies Note: This Panel has no lead presenter 1

3 Need for Tax Reform Is there one? Last major rewrite in Tinkering since then, including American Jobs Creation Act of 2004 (Sections 199, 965, 409A, etc.) and a series of temporary extenders (Sections 954(c)(6); 168(k)) The drafters of IRC framework on fundamentals of taxation of worldwide income, and FTC, Subpart F, and other key underpinnings (all done either pre-fdr or in Kennedy Administration) would recognize their work in today s IRC The world has changed (but the IRC has not) Inversion Debate was an example: Republicans and Democrats looked at same picture but viewed it very differently; companies reacting to a competitive global world? Or not paying their fair share Prior Reform Efforts: Camp I and II; Enzi; various other proposals; June 2016 House Blueprint and Trump Plan September 27 Big Six Framework and the November 2 Act 2

4 Corporate Rate The Act cuts rate from 35% to 20%. Change is immediate and permanent. Issues: How to pay for a corporate rate cut? Offsets (domestic and international); Spending cuts; deficits? The rate drives many of other terms of package; Revenue Neutral? By IRC Title? Reconciliation and Budget Resolution Compare to Blueprint (20%); Trump Plan (15%); Camp II (25%); Obama (28%) Average OECD Rate: 23-24% Another Stat: Percentage of Corporate Tax/GDP: U.S. (2.2%); OECD (2.8%) Debate over how burdensome U.S. tax rate of 35% actually is; Tax Foundation/Citizens for Tax Justice/Tax Policy Center 3

5 How to defend higher rate on individual and partnership income vs lower corporate rate? Should the lower corporate rate be extended to certain kinds of individual or partnership income? What is the rationale for such extension? What kinds of income should get a lower rate? business income investment income service income or income from your own efforts disguised wages and wage proxies should partnership income be distinguished from individual income? The Act adds measures to prevent the recharacterization of personal income into business income. 4

6 How to defend higher rate on individual and partnership income vs lower corporate rate? What are the practical problems with determining and policing the distinctions? current law s inbound effectively connected income distinctions the line between business and investment equity and hedge funds, carried interests, etc. what is reasonable compensation? Is it some fixed percentage of overall income? Is it all income in excess of a designated rate of return on assets invested? audit and enforcement 5

7 Maximum Rate on Business Income of Individual Owners of Pass-Through Entities Business income of individuals taxed at 25% rate. Rate is applicable to passive business income and an applicable percentage of active business income. Applicable percentage of active business income is based on capital percentage of active business income. Generally, capital percentage is 30%, leaving 70% of the individual s active business income subject to ordinary individual income tax rates. Alternatively, an individual may make a binding 5-year election to apply a formula measuring the capital percentage based on a rate of return (Federal short-term rate plus 7%) multiplied by the business capital investments. The proportion of business income would be determined by each owner of the pass-through entity separately. Special rules prevent recharacterization of actual wages paid as business income. Active or passive based on Section 469 principles. 6

8 Territorial System Finally, But If I were forming U.S. BigCo today I would form it in What are the problems of the current U.S. International Tax System: 1. Rate: 35% on Repatriation 2. CFC system designed in manufacturing era, when U.S. had 50% of world GDP, the Cold War prompted concerns about investment in developing countries and U.S. multinationals derived a fraction of income from overseas. 3. The ever-shrinking FTC (see last panel) resulting in double tax. 7

9 Territorial System for Future Foreign Earnings The Act replaces worldwide tax system with a 100% exemption for dividends from foreign subsidiaries (in which the U.S. parent owns at least a 10% stake) Eliminates the Lockout Effect Section 956 disappears for US corporate shareholders Foreign Base Company rules appear to continue in part No FTC on distribution including under Section 901, but see discussion below 8

10 Territorial System for Future Foreign Earnings: A New Era Lender US Parent Company Foreign Sub 1 Foreign Sub 2 Foreign Sub 3 Buyer Credit Support for Parent Debt Distributions and Loans to US Affiliates Sale of Foreign Sub Participation Exemption? 9

11 Territorial System: Base Erosion Issues Act imposes a minimum tax generally at 10% rate (20% corporate rate x 50% of foreign high return amount ) of a U.S. multinational AND enacts rules to (in the Framework s words) level the playing field between U.S.-headquartered parent companies and foreignheadquartered parent companies (see Section 4491 later). Opposing statements? How can they possibly be reconciled? Policy goal of Minimum Tax? Revenue offset for Corporate Rate Cut? Revenue Neutrality on International Provisions (each Title )? Protection of U.S. Tax Base? Probably main reason. Act: Under current law, allocation of income by U.S. companies to intangible property in low-tax jurisdictions is an acute source of erosion of the U.S. tax base. The adoption of a dividend-exemption system could, without appropriate safeguards, exacerbate this incentive by allowing profits that have been shifted to be repatriated with minimal U.S. tax consequences. 10

12 Prior anti-base erosion minimum tax proposals Proposal Chairman Camp H.R. 1 (2014) Senator Enzi S (2012) Obama Budgets FY16/17 U.S. rate 25% 35% < 35% Foreign dividends 95% exemption CFC or section 902 corporation 95% exemption CFC or electing section 902 corporation Replaced with minimum tax Tax base As in Option C, income of a CFC that is from intangibles and lowtaxed becomes a new category of Subpart F income -- Foreign Base Company Intangible Income ( FBCII ) FBCII measures a CFC s low-taxed, foreign intangible income by reference to the excess of (A) the CFC s gross income > 10% of asset basis (the Excess ) over (B) a percentage of Subpart F income. The percentage is the Excess/gross income. (AGI > 10% QBAI) (Excess/AGI x other Subpart F income). New category of Subpart F income for low-taxed CFC income measured as all gross income less qualified business income ( QBI ) that is in excess of minimum tax All low-taxed foreign earnings Minimum tax 15% minimum tax on foreign intangible income Foreign ETR 50% of U.S. rate (i.e., 17.5%) Determined country by country (branches not addressed remain disregarded) QBI is same country income, which requires either employee / officer presence, but does not include intangible income 19% minimum tax on foreign earnings, reduced by 85% of the per-country foreign ETR (i.e., minimum tax applies if ETR 22.4%) An allowance for corporate equity ( ACE ) - intended to exempt a return on actual activities abroad from the min tax Foreign branches No change in foreign branch income taxation No change in foreign branch income taxation Treated as CFC for minimum tax U.S. incentive 40% U.S. tax deduction against foreign intangible income earned directly by U.S. corporation or foreign corporation that is included in U.S. shareholder s gross income as Subpart F income The deduction does not apply to property sold or services provided back into U.S. (prevents round tripping where goods are sold outside the U.S. but ultimately provided to an end-user in the U.S.) A 50% deduction (i.e., 17.5% rate) for U.S. corporation s qualified foreign intangible income ( QFII ): derived from the active conduct of a business in the U.S., provided the U.S. corporation developed the intangible property, or, if acquired, added substantial value to it within the U.S. New 20% general business credit for expenses in connection with insourcing U.S. trade or business No U.S. deduction for expenses in connection with outsourcing U.S. trade or business 11

13 Minimum Tax Proposal: New Code Section 951A Foreign High Return Amount 1. Foreign high returns would be measured as the excess of the U.S. parent s foreign subsidiaries aggregate net income over a routine return (7 percent plus the Federal short-term rate) on the foreign subsidiaries aggregate adjusted bases in depreciable tangible property, adjusted downward for interest expense. 2. Treated similarly to Subpart F income. FTC limited to 80%. USP FS1 FS2 FS3 FS4 FS5 FS6 Country A Country A Country C Country C 12

14 Minimum Tax Proposals: Grubert & Altshuler: Fixing the System 1. A country-by-country minimum tax of 15 percent on active income. FTC for foreign tax rate up to the 15 percent threshold. Effective tax rates computed for income in each jurisdiction. No active business exception. Calculation based on straightforward E&P. 2. Same as 1. except calculation allows company to deduct real investment in the country from the minimum tax base. No U.S. minimum tax on the company s normal return abroad. Only excess return is taxed. USP Dutch Min Tax Base Dutch Min Tax Base EU EU EU EU Country A Country A Country C Country D 13

15 Minimum Tax Proposals: Grubert & Altshuler: Fixing the System 1. An overall group (i.e., treat foreign subs as one CFC ) minimum tax of 15 percent on active income. FTC for the effective foreign tax rate up to the 15 percent threshold. No active business exception. Calculation based on straightforward E&P. 2. Same as 1. except calculation allows company to deduct real investment in the country from the minimum tax base. No U.S. minimum tax on the company s normal return abroad. Only excess return is taxed. USP Dutch Min Tax Base Dutch EU EU EU EU Country A Country A Country C Country D 14

16 Minimum Tax: Categories of Income USP FS1 FS2 FS3 FS4 Classic Foreign Personal Holding Co. Income* Foreign Base Company Sales or Service Income Active Non-FBC Income (ETR is 8%) Active Non-FBC Income (ETR is 20%) Which of these categories should be subject to Minimum Tax? * Presumably subject to regular corporate tax rate as under current law. 15

17 Other Issues Regarding Territorial System and Minimum Tax FTC: Allowed at 80% level against Minimum Tax. Section 902 repealed but section 960 continues to apply for Subpart F inclusions. Is a Minimum Tax a cost or revenue offset for a territorial system? Is that fair? Territorial system has a cost when measured vs. 35% rate, but far less so vs. 20% rate. 16

18 How can a Minimum Tax on Foreign Profits be Reconciled with Level the Playing Field Questions we were thinking about on November 1: To level the playing field might mean tilting the field more in favor of U.S. parented group? A repeal of things like section 956 would help. But a Minimum Tax by definition unlevels that field? Or it might mean tilting the field against Foreign parented groups with new inbound rules? Might they be thinking: Further limits on base erosion? Tightening 163(j)? An inbound Minimum Tax? A gross basis surtax? See Testimony from several experts before Senate Finance Committee on October 3. Note the EU approach on its inbound taxation of U.S. tech companies. 17

19 New Section 4491 Imposition of Tax on Certain Amounts from Domestic Corporations to Foreign Affiliates FP US Sub Royalty Payment FS1 Manufacturing Assume US Sub purchases product or makes royalty payments to foreign affiliates. 20% excise tax on payments unless ECI elected 18

20 Territorial System: Base Erosion Issues How will other countries react to a U.S. Territorial System and an outbound Minimum Tax? Or an inbound Excise Tax? Will they enact new withholding taxes on repatriation back to U.S.? Since deferral no longer a likely goal for US tax planning companies may pay more frequent dividends up the ownership chain. Will they enact a soak up for Minimum Tax? Is Minimum Tax a defense against State Aid claim due to no more stateless income? Can U.S. object to EU actions on U.S. multinationals if U.S. imposing its own inbound Excise Tax? 19

21 Territorial System What about Gains? Is there any kind of participation exemption on sale of CFC? Prior bills differed. Is there a true exemption system without a participation on sale exemption? US Company #1 US Company #2 Foreign sub Foreign sub Current and accumulated profits (historic losses) Assume Company #1 captures business advantages with current profits. Assume Company #2 reinvests revenues in R&D, brand enhancement, etc. Both U.S. companies sell Foreign Subs. Should U.S. Company #2 pay regular tax on gain? Is that fair given U.S. Company #1 had the tax benefits of a lower Minimum Tax on accumulated earnings? 20

22 Territorial System What about Gains? When a USP sells a FS, should there be a mandatory type of section 338 election? Deemed sale gain being exempt under a participation regime except the extent attributable to FPHC type property? US Company #1 US Company #2 Foreign sub Foreign sub Current and accumulated profits (historic losses) 21

23 One Time Tax on Accumulated Overseas E&P Act: This is not a repatriation holiday (such as 2005), but rather a one time tax at 12% (cash and cash equivalents) and 5% (other assets) imposed on historic earnings; payable over 8 years. Unlocking $2.5 trillion of earnings will it boost the economy? 22

24 One Time Tax on Accumulated Overseas E&P USP FS1 FS2 FS3 FS4 Deficit Positive E&P Excess Cash Third Party Debt FS1 deficit in E&P appears to offset FS2 positive E&P in calculating tax base. If FS3 has cash or cash equivalents should it somehow be offset by debt payable by FS4? 23

25 Expensing, Major Credits & NOLs Policy goal: Encourage investment Act: Full and immediate expensing of new investments in depreciable assets made after September 27, 2017, for at least five years; Maintain R&E Credit; envisions repeal of other credits though under review depending on budget limits; Special rules on NOLs Blueprint: Full and immediate expensing of tangible and IP; Maintain R&E Credit with modifications; NOL carryforward indefinite (90% limit) Camp II: Repeal MACRS; lengthen lives/inflation index; section 197 set at 20 years; NOLs allowed (90% limit) 24

26 Interest Expense Current Law: Gross interest expense is deductible, subject to limits where arguably disguised equity (AHYDO rules; Sections 163(L), 163(j), 385, Litton, Nestle and other classic cases) Policy goal? Equalize debt/equity (note Hatch approach of deduction for equity); raise revenue; prevent base erosion; does Congress see societal benefits (is debt good?) Framework: deduction for net interest expense (NIE) incurred by C corporations partially limited ; Committees to consider appropriate treatment of interest paid by non-corporate taxpayers, indicating special rules for noncorporate taxpayers? Blueprint: Disallowed NIE deduction; with a reference to special rules for financial services companies Camp II: No broad limits; Special rules for U.S. Parented groups with CFCs 25

27 Interest Expense What is NIE? Interest equivalents on income and expense side What are the alternatives to partially limit NIE? Flat Percentage Limit on Deductible Net Interest Expense? - [50%] of NIE deductible in any given year. - What if NOL? Carry forward of Excess NIE? Limit NIE based on overall Group EBITDA? Like Germany. - What of Non-U.S. EBITDA of U.S. Parented Group? Policy issues of each alternative? Why is interest treated differently than, say, electric bill for Corporate HQ? They are both expenses? These were the questions on November 1 26

28 Interest Expense New Section 163(j) Limited to 30% of ATI Excess interest expense carried forward Special Rules in Section 381 and 382 Transactions Deductible net interest expense of U.S. corporation in international group would limited to the extent the U.S. corporation s share of the group s global net interest expense exceeds 110% of the U.S. corporation s share of EBITDA; limit to apply in addition to the general rules. Effective

29 Interest Expense Would current debt be grandfathered? Appears not. Administrative (IRS Exam) challenges Scoring challenges Financial Services Entities Leasing Arbitrage Opportunities 28

30 Interest Expense For a US Parented Group, how should any limit apply taking into account principles such as those embedded in Allocation/Appointment rules of Section 861? USP Subpart F Income and Foreign High Return Amount Appear to be Included in EBITDA FS 29

31 Other Issues Transition Rules Taxation of Interest and Dividends Special Industries Will this Act be more like 1981 (to be followed each of the next several years with fairly significant substantive legislative updates); or more like 1986 (with only technical corrections for the most part) 30