US Tax Reform Key provisions and their impacts on financial services companies EMEIA Financial Services January 2018
Overview The US Tax Cuts and Jobs Act was passed at the end of 2017 and represents the most significant US tax reform in 30 years. Most provisions take effect from 1 January 2018 and will need to be carefully considered from 2017. This reform will have impacts beyond tax and not just on USheadquartered financial groups. Foreign financial groups with a US presence will need to review the impact on: Financial reporting and tax function readiness Funding/treasury and intra-group services Capital management Workforce strategies In the short term, the key challenge is to address the yearend financial reporting consequences of the reforms. After this initial period, clients will need to consider how they respond to the broader impacts. The issues include the financing of US operations, US dollar funding, corporate holding structures, treasury management and location of operations. Front offices will need to consider impacts of these tax reforms on US debt and equity markets, and other banking and trading businesses. This document summarizes the short- and long-term impacts of the reforms. Highlights of the bill The highlights of the bill include: Reduction of corporate income tax to 21% Introduction of Base Erosion Anti-Abuse Tax (BEAT) which could give rise to additional tax costs on crossborder related party payments Sweeping international reform: Territorial tax system Expanding the current taxation of non-us subsidiaries Incentivizing US exports 1 US Tax Reform: key provisions and their impacts on financial services (FS) companies
Potential business implications of US tax reform In the light of the changes in US tax reform, companies should evaluate the following: Operations Now that US tax reform is enacted shifting the US to a more competitive environment companies should evaluate: Current and prospective location of operations Impact of the US anti-base erosion provisions on areas, such as funding, intra-group services set-up and deferred compensation structures Updates to systems in order to comply with the Government and regulatory reporting Financial statements Companies will need to understand the immediate impact of legislation on financial statements in the period enacted and consider: Capital impact due to lower tax rate driving reduction in deferred tax assets Income statement impact of tax rate reduction and transition tax Timing to report impact of the reform Changes to systems, processes and internal controls over financial reporting Disclosures of impacts and tax rate guidance, including BEAT aspects Additional audit procedures required Change management Value chain Assess cost Financial statements People Prepare for change Liquidity and investment Drive multifunctional involvement People Tax reform legislation alters the landscape of executive compensation and employerprovided benefits while considering: Executive compensation structures Design of benefits programs Workforce strategy, sourcing, retention and location Immigration risk and compliance Regulatory capital Impact of lower rates and provisions needs to be evaluated: Favorable impact on regulatory capital forecast as a result of lower tax rate Unfavorable changes to the utilization of net operation losses (NOL) may impact tax planning strategies with impact on timing deferred tax assets (DTA) and therefore regulatory capital Liquidity and investment Related party borrowing and intercompany trading can result in deductibility restrictions and BEAT Review of (regulatory) funding and capital deployment with respect to domestic and offshore businesses to improve global interest deductibility Active offshore earnings above a minimum tax rate will generally be exempt from incremental US tax upon repatriation Includes repos/reverse-repos and other funding structures US Tax Reform: key provisions and their impacts on financial services (FS) companies 2
Impact on FS groups with operations in the US Provision Short-term impact Longer-term impact 1. Rate reduction From 1 January 2018, the corporate tax rate was reduced from 35% to 21% 2. Anti-base erosion measures BEAT Alternative minimum tax that may disallow a US deduction on foreign related-party payments Five percent for year one, 10% thereafter and increasing to 12.5% from 2025 (additional 1% for banks and broker dealers) The BEAT is compared with the ordinary tax liability of the taxpayer and the higher of the two is due The BEAT is of major concern to FS clients and could lead to a significant increase in US tax liability. This provision is one of the main issues inbound FS clients are facing 3. Interest expense restrictions Interest deductions limited to 30% of earnings before interest, tax, depreciation and amortization (EBITDA), further restricted to EBIT beginning in 2022 Applies to related and unrelated party debt Re-measurement of US DTA/ deferred tax liabilities (DTL) impact for year-end reporting Measurement of BEAT impact for year end impact on US DTA Uncertainty on recognition and measurement for IFRS reporters Stakeholder appreciation that the BEAT applies to current transactions FS companies with positive spread unlikely to be affected Lower tax rate on US earnings Supply chain impacts Combined with other measures, it might encourage movement of activity to the US. Clients will need to consider funding arrangements, transfer pricing (TP) set-ups, service company structures, etc. Cost of capital US inbounds with non-us intragroup funding may find themselves uncompetitive compared with wholly US-funded businesses. Location of operations Supply of services from outside the US could incur additional BEAT costs. Planning opportunities Capital, treasury, service structures, TP and supply chain/ operations review to influence BEAT Business and service structure, e.g., branch or subsidiary structures Reinsurance Additional tax substantially affects related-party cross-border reinsurance, particularly from a US ceding to a foreign reinsurer; potentially restructuring and capital impacts Debt markets to review products to take account of new rules To the extent interest is restricted, consider capitalizing relatedparty debt and methods to boost EBITDA/EBIT 3 US Tax Reform: key provisions and their impacts on financial services (FS) companies
Impact on FS groups with operations in the US Provision Short-term impact Longer-term impact 4. Loss restriction For losses arising in tax years beginning after 2017, the loss deduction would be limited to 80% of taxable income. Re-measurement of DTA s Carryback elimination affects regulatory capital calculations. Hypothetical losses cannot be carried back, thus creating a NOL DTA disallowed from capital. Loss limitation will limit tax planning strategies which may have to be reviewed i.e., loss refresher transactions may have to be reassessed. Potential impact on recognizable DTA and DTA recognition methods 5. Transition tax A one-time transition tax is levied on a US corporation s foreign accumulated untaxed earnings at a 15.5% rate for cash/cash equivalents and an 8% rate for the balance. 6. Participation exemption Dividends received from 10%-owned non-us subsidiaries would be exempt from US tax, though capital gains would still generally be subject to US tax. 7. Global intangible low taxed income (GILTI) Effectively imposes a global minimum tax on US parented or owned group companies outside the US Expands the current US taxation of non-us subsidiary income 8. Foreign derived intangible income (FDII) Provide incentives for the export of services from the US by providing a beneficial tax rate Tax accounting Computation may present extreme complexity as there is a need to determine post-1986 earning pools and historic tax payments to substantiate any foreign tax credit attributable to post-1986 earnings. Tax accounting Impact on deferred tax assets and liabilities DTA measurement and effective tax rate (ETR) impact Expected to disproportionately impact FS clients due to low level of tangible assets Partially erode benefits of lower headline tax rate and territorial tax system DTA measurement and ETR impact Lower US tax rate (13.125%) on exported services Excludes FS income which will limit benefits to FS clients Payment Potentially significant cash flow needed to pay tax Transition tax may be paid over eight years subject to certain triggering events. The bulk of the transition tax, 60%, is payable in years six to eight. Cash repatriation eased Ability to efficiently move funds back to US owners facilitated due to lack of arising tax liability Review out from under planning Reconsider US ownership of non-us subsidiaries to influence long-term implications of GILTI Supply chain impacts Combined with other measures, may encourage movement of activity to the US US Tax Reform: key provisions and their impacts on financial services (FS) companies 4
Impact on FS groups with operations in the US Provision Short-term impact Longer-term impact 9. People Executive compensation Fringe benefits Very short period to assess the impact of changes to employment related taxation which became effective on 1 January 2018 Employment Deductible limits on US executive compensation and limited deductions for fringe benefits may increase the true costs of US employees as well as impact the cost of expatriate packages into the US. When combined with other provisions, the location of US-based employees need to be considered. 5 US Tax Reform: key provisions and their impacts on financial services (FS) companies
How EY can help EY has more than 50 US tax and accounting professionals dedicated to financial services in London who focus on the EMEIA market. Our US tax team is able to rapidly help in understanding of the US tax reform legislation, consider the short- and long-term impacts it raises, and your reaction to it. Our tax teams can immediately provide: BEAT planning, technical analysis of the tax reform provisions and modeling of tax impact Resources/secondment opportunities to address yearend accounting aspects and fill client resourcing gap Tax tools to estimate: repatriation tax, interest limitation, BEAT Contacts For more information and an approach tailored to your needs, please contact our team. Tax Banking and Capital Markets Ralf Eckert Partner, Ernst & Young AG T: +41 58 286 3559 E: ralf.eckert@ch.ey.com Richard Milnes Partner, Ernst & Young LLP T: +44 20 7951 7750 E: rmilnes@uk.ey.com Andy Martyn Partner, EMEIA Transfer Pricing lead, Ernst & Young LLP T: +44 20 7951 9539 E: amartyn@uk.ey.com Tax Insurance Tax Wealth and Asset Management Thomas Brotzer Partner, Ernst & Young AG T: +41 58 286 3412 E: thomas.brotzer@ch.ey.com Linda Henry Partner, Ernst & Young LLP T: +44 20 7951 8618 E: lhenry@uk.ey.com US Tax Specialists Tobey Schumacher Associate Partner, Ernst & Young LLP T: +44 20 795 18342 E: tschumacher@uk.ey.com Dan Farrell Partner, Ernst & Young LLP T: +44 20 7760 9324 E: dfarrell@uk.ey.com US Tax Reform: key provisions and their impacts on financial services (FS) companies 6
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