Tax reform implications for manufacturers

November 13, 2017

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By John Livingstone

It has been a busy ten days for tax executives and practitioners as they review the relevant provisions in the tax reform legislation taking shape right now in the US House and Senate, and more significant developments are expected in the coming days.

The House and Senate are each crafting their own tax reform bills and at some point the two chambers will need to reconcile them. The Ways and Means Committee on November 9 completed its tax reform bill, and the full House of Representatives is expected to debate and vote on the legislation this week.

Meanwhile, the Finance Committee is expected to begin consideration of Chairman Hatch’s bill this afternoon, with the markup continuing through the week. Unlike the House Ways and Means Committee, which marks up statutory text, the Senate Finance Committee is expected to conduct a ‘conceptual’ markup based on the JCT staff description of Chairman Hatch’s reform bill. In the Finance Committee’s normal course, legislative text of the bill would be released following the markup. We understand, however, that the Finance Committee is considering releasing legislative text earlier than that.

Both the House and Senate tax reform proposals seek to lower business and individual tax rates, modernize US international tax rules, and simplify the tax law, but they differ in some key aspects.

For manufacturers, there are numerous new implications to consider.

Both bills propose a permanent cut to the corporate tax rate from 35% to 20%. The Ways and Means bill wants that cut right away – as does the White House. But the Senate wants to delay it by a year. This would lower the cost of their bill by more than $100 billion and give them more revenue to use for other changes.

Notwithstanding this policy choice in the Senate, some Republicans in that body have suggested that the effective date of the corporate rate may be subject to further discussion and negotiation.
Despite the debate over timing, both agree the cut should be permanent. That, combined with the transition to a territorial system of taxation with a 100% deduction for foreign dividend income, is very welcome.

Transition to a territorial system will allow companies that tend to operate globally to access foreign cash tax efficiently. Additional notable benefits include retention of the R&D credit and immediate expensing of the cost associated with certain qualifying property.

Other provisions could be detrimental for some companies and are therefore less welcome. Significant limitations on the deductibility of interest expense could be costly to companies with significant US borrowings, a fact pattern that broadly exists for companies in the sector. Additionally, the proposed cost of the deemed repatriation provisions related to historic earnings, payable over eight years, go beyond what many observers were expecting, particularly in the House Bill. The elimination of the domestic production deduction also will come with a steep cost for most in the sector. Additional limitations on the deductibility of certain types of executive compensation will also be costly.

On the anti-base erosion front, provisions in both bills targeting the high return income of a US company’s foreign operations that are subject to low foreign tax rates are included and will impact companies in the sector to varying degrees. However, a proposal in the Senate Bill that provides a benefit for foreign-derived intangible income generated from a trade or business in the United States could be a significant benefit for high-value exporters of goods and services.

And then there is the very controversial Excise Tax provision in the House Bill. The 20% excise tax on certain amounts paid to certain related parties was a surprise to most. A provision allowing the foreign corporation to treat the payments received as effectively connected income and subject to a reduced foreign tax credit in lieu of paying the excise tax will likely be preferable in most instances. The provision is very costly to those that operate in global markets and have built global supply chains. Additionally, it has some wondering what retribution it might elicit from US trading partners.

The good news is that, on balance, most companies in the sector will likely benefit from the proposed reforms even if certain proposals have more bite than expected. A permanent low corporate rate and access to foreign cash will be appealing to a broad array of companies across the sector.

There are many political hurdles to overcome for Congress to pass sustainable reform of US tax law providing a more competitive tax system for business taxpayers and improved economic opportunities for individuals and families. Companies that have concerns should actively engage with policy makers in Congress as legislative negotiation is taking place now. For more on the House and Senate bills, visit our Tax Insights.

 

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