The new United States Tax Cuts and Jobs Act (officially known as "an Act to provide for reconciliation pursuant to Titles II and V of the concurrent resolution on the budget for fiscal year 2018") (the “Tax Act”) went into effect January 1, 2018. This article posits that inbound investment into the US is poised to grow significantly as a result of the Tax Act and examines some related cross-border areas that should be carefully considered by a foreign companies operating in the US. This discussion is not intended as a detailed tax analysis of the Tax Act for which an experienced cross-border CPA should be consulted.
The US has long relied on its dominant economic power in the world to attract foreign investment. However, its corporate tax rate has lagged behind other industrialized nations. The maximum federal corporate income tax rate until this year (under a progressive tax system) was 35% (plus applicable state income tax). The new Tax Act introduces a flat corporate tax rate of 21% which is not only competitive with, but in some cases lower than, other industrialized nations. The corporate alternative minimum tax (AMT) was also eliminated. In most cases, these changes will result in tax savings on income earned by foreign-owned US businesses. Given its dominant position in the world, and setting aside other fluctuating variables which may affect the US economy, it seems likely that foreign investment into the US will grow, perhaps substantially, as a result of the Tax Act.
Nevertheless, a foreign company operating in the US should take a nuanced view of the Tax Act. The Tax Act contains both benefits and potential drawbacks and appropriate business and tax planning is important.
A critical aspect of foreign-US related or affiliate company structure is transfer pricing planning. The Tax Act directly impacts such structuring.
It is common for foreign companies to form US subsidiaries and thereafter enter into transfer pricing agreements between the parent company and the US subsidiary for items such as intercompany administrative services, management services and/or intercompany IP licenses. In the case of start-up US subsidiaries, these agreements are especially necessary because the US subsidiary often has limited expenses (few or no employees, less leasing costs, etc.). Instead, all or most of the back-office services to support US operations are provided by the parent company in the home nation. This results in US revenues which are not accompanied by associated US expenses but which instead are incurred in the home nation. Historically the US tax rate has been significantly higher than most home nation tax rates which generally has incentivized having lower taxable US profits. Transfer pricing agreements are intended to harmonize revenue and expense in the two jurisdictions and, often, reduce US profit in accordance with complicated transfer pricing regulations.
At first blush, the reduction of the US corporate tax rate to 21% eliminates a common reason for transfer pricing planning. Caution is advised, however, because the Tax Act expressly discourages strategies to exploit gaps in tax rules to artificially shift profits to low or no-tax locations (“base erosion”). Not only will transfer pricing agreements remain important to comply with applicable transfer pricing regulations, but the Tax Act introduces a new US tax to discourage base erosion. The base erosion anti-abuse tax (BEAT) generally applies to deductible payments to foreign affiliates (such as those made under transfer pricing agreements) and is in addition to the US corporate income tax. Fortunately, the BEAT has a significant threshold that takes into account substantial annual gross receipts of a taxpayer which means that many lower to middle market companies should not be affected (i.e., gross receipts greater than $500 million). Large companies that would be affected by BEAT may rely on exemptions. A US subsidiary subject to BEAT can generally exempt payments made to foreign affiliates for services provided at cost. Note, however, the foreign affiliate’s country of residence may not allow for pricing at cost under its own transfer pricing laws. Transfer pricing agreements will be necessary to document such services (and perhaps to separate cost versus mark-up) with further analysis warranted. Existing transfer pricing agreements should be reviewed and modified as appropriate to account for the changes made by the Tax Act.
As new reporting requirements for BEAT and penalties are introduced, an accounting firm familiar with the nuances of the Tax Act and BEAT should be consulted prior to the filing of corporate tax returns for 2018 and beyond.
Seemingly unaffected by the Tax Act should be the prevalent use of C-corporations by foreign owners in the US. Unlike US owners of US businesses who prefer pass-through entities, such as US limited liability companies (“LLCs”), foreign owners often prefer to use C-corporations since it generally avoids the US branch profit tax (which does not affect US owners), allows the parent company to take maximum advantage of any income tax treaty benefits, and because many foreign nations do not recognize the pass-through tax treatment of LLCs. The reduction of the corporate tax rate to 21 percent, coupled with the elimination of the corporate AMT, should further strengthen the C-corporation as the entity of choice for most foreign owners.
In sum, while the Tax Act promises benefits to most foreign companies in the US, each foreign company should conduct a nuanced and customized analysis of the Tax Act. The particular impact will vary depending on numerous factors, including size and industry. Analysis by an experienced cross-border tax professional, in collaboration with a cross-border corporate attorney, is recommended. Taking such action will ensure that US operations are compliant and conducted in the most optimal and cost-efficient manner.
About this author.
Steve Suneson practices law at Coan, Payton, and Payne LLC, and specializes in the business law and commercial transactions.